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Thursday, December 8, 2011

Jack Delano The Planters March 1941"Planting corn on a plantation near Moncks Corner, South Carolina"

Ilargi: Earlier today, in a fancy location in Brussels, - no, you're right, they probably had it €500 a plate catered, can't take the risk of venturing out into the real world where the people live they're supposed to represent-, one bullet-proof limo after another arrived to deliver the honorable hoity-toity from 27 EU countries and their servants for an informal gala dinner during which they could, in hard-fought peace, discuss the maximum extent to which austerity measures can be taken in various member countries without provoking outright civil war.

Security costs? Just a few million bucks; what are you insinuating? We do this every week.

And I'm thinking: the limo's may be bullet proof, but they're certainly not fool proof.

It links up perfectly with something the Polish Prime Minister said to his MPs this week: "You're either at the table or you're on the menu."

Only, he meant his country's government should have a say in what goes on (not just France and Germany). He did not mean the people of Poland themselves should be at the table. They are, like all other European people who were not delivered by bullet-proof limo to attend the dinner, very much on the menu. It's the 1% vs the 99%.

"European leaders Merkel and Sarkozy have reached "complete agreement" (mostly) on a new treaty that would restrict the budgeting and size of future deficits for eurozone nations. ", or so I read somewhere this week. Sounds great guys! Problem is, though, that the problem is not future deficits, it's present ones. What do you have for those?

Thing is, they have nothing. The EFSF stability fund was supposed to be leveraged up to €2 trillion or more. Not happening. The ECB was supposed to buy trillions in useless and worthless sovereign periphery bonds. Not happening. Geez, wonder why. Incestuously adding the EFSF to its own daughter (just temporarily..), the ESM; actually proposed. But not going to happen.

The busiest people today and tomorrow in Brussels at the EU meeting are the spin doctors. It’s about form, not content. Not what you say, but how you say it. They have nothing. The interests of the countries involved are by now so far apart, it's somewhat insane that Merkel and Sarkozy even try to maintain that "we're all in this together" stance.

Well, then again, they have by now both realized what predicament they're in. There's no way out that would allow either to keep their jobs. So they're together in that at least. But it's not going to be for their lack of trying!

For the financial markets, Merkel and Sarkozy, and all the rest of Europe, have long since lost all credibility. So they may pretend to be still in control, but there is no such thing as control without credibility. It’s all about faking it from here on in.

Look, the US has a constitution. The EU has 27 different constitutions. Some modeled after England, some after France, some after the US, and some just made it up as they went along. There are lawyers and judges in all these 27 countries that know their respective constitutions.

And I'll leave you a wild guess as to how many of them stipulate that you can't just sign away broad based sovereign powers and rights to Brussels or anyone else without first consulting your parliament and/or your people.

Whichever grand scheme comes out of this summit will have to, if it were to be any good in achieving any of the goals they're aiming for, include parts that violate the constitutions of at least some of the 27 EU members. Cue referendums, cue elections, cue many months of delay that isn't realistically available.

Most European banks, all 17 Eurozone countries, all 27 EU countries, the EFSF and the EU itself are now all under credit downgrade watch. If there is no grand enough plan on Friday evening, S&P, Moody’s and Fitch will start picking them off one by one, downgrade by downgrade.

With devastating consequences for the Eurozone: the downgrades will be perceived and taken as accumulative, not separate. Can't do the math, you're not alone. Just watch it unfold.

Which will in turn lead to higher interest rates on sovereign bonds, which will lead to less growth (make that more contraction), which will lead to more austerity, which will lead to less growth, which will lead to more downgrades etc. Yes, children, deflation is a bitch.

But even then, going forward the sovereign issues will turn into nothing more than a sideshow. The banks will be the main issue from here on in. If there is no consensus within the EU to support European banks (and how could there be with both French and German - and everyone else's - banks on the perch?), that will be even more apparent, but even apart from that fight, things are plenty ominous.

The whole H. Mary Dumpty is falling to pieces, and there isn't a Merkel in the land to put it back together again.

While the EU leaders talk about sovereign debt issues, they are being overtaken and incapacitated by what's happening in the banking world. It really doesn’t matter what they decide.

The smart people in the markets have long since realized that there are so many vulnerabilities in the very system they make their money in. They can sit back, pick off countries and financial institutions one by one, get rich, eat grapes, boink their servants and play their harps while Rome burns and loves them long time. The EU as fish in a barrel.

Many of these people work for, with or through those financial institutions. From that angle it shouldn't perhaps be all that surprising that they go after sovereign countries first. The next step, going after the banks, will feel like cannibalism.

Still, why would they want Rome to burn while they live and prosper in it? Simple: they know it'll burn no matter what. But they’ll live long enough to see it, and enjoy the spectacle. After them, the flood.

EU banks will have to meet new capital requirements at the exact time when hundreds of billions of euros in debt needs to be rolled over. Which if at all possible, will lead to substantial increases in interest to be paid. Damned if you do, doomed if you don't. Not an unfamiliar theme.

They are borrowing - near - record amounts of dollars these days. Lots of USD denominated debt that needs to be serviced. The ECB base rate cut to 1% today is mere window dressing. Even the stock markets got that one right.

Come on guys, there's way over $2 trillion in toxic assets sitting in European bank vaults. Who's going to take that on? Not the EFSF, it can’t even get to €900 billion, and that is meant for sovereigns, not banks. Not the ECB, which would itself be downgraded if it even tried. Come to think of it, downgrading a central bank would be a sight to see ... Harry Wilson for the Telegraph:

Europe's banks must dispose of a pool of toxic assets larger than the entire British economy if they are to return to profitability and meet new capital rules.

Estimates from accountants Deloitte found that European banks currently hold more than £1.5 trillion of non-core and non-performing assets on their balance sheets. Deloitte said that while banks will have to dramatically shrink the size of their asset books they are likely to face major challenge in doing so given the scale of the bad loan problems they face.

British banks, despite beginning their disposal programmes much earlier than their Continental European peers, still have by far the biggest pile of toxic assets. Deloitte estimates the size of the non-core and non-performing assets held on the balance sheets of UK banks at £460bn, more than the combined total for Ireland, Spain and Italy. German banks come a close second with a toxic asset pool of about £447bn.

Ilargi: Still no mark-to-market, right? That comes back to bite every single time. Even German banks ain't doing all that grand, warn Martin Hesse and Anne Seith in Der Spiegel:

European banks could require up to €200 billion in fresh capital, with the Germans alone needing €10 billion. Commerzbank is likely to account for approximately €5 billion of this, and Deutsche Bank for nearly €3 billion.

Where is the money supposed to come from? "It's a mystery to me how some banks can be expected to meet the higher capital requirements at such short notice," says bank expert Michael Göttgens from the auditing and consulting company Deloitte.

The traditional way would be to raise capital by issuing new shares on the stock exchange. Investors, though, are avoiding European bank stocks precisely because of the sovereign debt crisis. To make matters worse, financial institutions will probably also generate lower returns over the long term due to the more stringent regulatory demands.

Only Italy's largest bank, Unicredit, and Austria's Raiffeisen Bank have dared to announce significant capital increases. Unicredit, which owns Germany's HypoVereinsbank, intends to raise €7.5 billion -- although it recently made a loss of €10 billion in just one quarter.

Ilargi: While Spain wants to clean up its banking system, drowning in ghost towns, with $236 billion in capital it definitely doesn't have. Probably want the EFSF to pick up the tab. What's "dream on" in Spanish again? WSJ's Jonathan House and Christopher Bjork:

Spain's incoming prime minister, intent on curing the country's ailing banking sector, is considering cleanup plans that could dwarf the cost of previous efforts, including the creation of a state-funded "bad bank" to acquire toxic assets or a move to force banks to dramatically boost loan-loss reserves, people close to the situation say.

Prime Minister-elect Mariano Rajoy has said he wants to speed up the process of dealing with €176 billion ($236 billion) of impaired real-estate assets from Spain's housing bust, although he played down the potential cost of his plans ahead of last month's elections. The bad assets are choking off the flow of credit and making international investors wary of the euro zone's fourth-largest economy.

Ilargi: The Greeks are one step further along in the natural progression of things, suggests Ferry Batzoglou in Der Spiegel:

Many Greeks are draining their savings accounts because they are out of work, face rising taxes or are afraid the country will be forced to leave the euro zone. By withdrawing money, they are forcing banks to scale back their lending -- and are inadvertently making the recession even worse.

Ilargi: And then you still get something like this from Brooke Masters at FT:

... there is growing concern that some banks may be tinkering with the way they measure the riskiness of their assets [..]

Ilargi: Oh, is that so? And that's why you now are looking extensively into what that tinkering may or may not entail? And that could take you a while (re: years), because it's all very complicated?

Here's what I think: Regulators who try to regulate the system now, after it’s already effectively collapsed, should all be fired. Without benefits. As should any remaining politician under whom they worked. Make that retroactive. It can't be that in 2011 the designated regulators still don't have a clue what banks are doing.

We're not running a freak show around here. We're trying to have a viable society, to make sure 99.9% of people have at least something to eat going forward, a roof over their head. A government that either is not clever or not willing enough to look at what lack of regulation enabled banks to lose that money in their casinos that now force people to skip meals because their money is being used to bail out the banks, is a government without a raison d’être (a reason to be). And that's putting it very mildly.

And yes, I do know that no matter how angry I get at all this incompetent stupidity, it's already far too late anyway, seeing what Kelly Evans reports for the Wall Street Journal:

Bank runs aren't a relic of the 20th century. In fact, they risk becoming a hallmark of the 21st—though with a twist.

The 2008 financial crisis displayed characteristics of a classic bank run, but people holding bank accounts weren't the ones scrambling to get their cash. It was lenders demanding their money from other financial institutions.

Indeed, today's panics are more likely to involve major financial institutions and are largely hidden from plain sight until they are severe enough to trigger plunging stock prices, bankruptcies, layoffs and rising unemployment. [..]

At best, shadow banking offers financial institutions a source of funding and liquidity on a day-to-day basis. At worst, it allows the buildup of leverage and systemic risk, as the 2008 financial crisis revealed.

Gary Gorton, a Yale University professor and leading researcher in this field, has documented that the crisis was effectively "a run by banks and firms on other banks."

Ilargi: Maybe it would be a good idea to get to your money before some bank does.

And that's even before we consider what Reuters, Tyler Durden and Karl Denninger have to say about the aftermath of the MF Global collapse, in which banks, through a deliberate UK legal loophole, have been able to gamble away all their clients' funds and them some through "re-hypothecation", after which they stand first in line, before the very same clients, to get reimbursed.

Bonnie and Clyde and Jesse James may have been turned into American folklore, but they still killed people. The same goes for a government and regulators supporting a morally bankrupt and rudderless financial system that's starting to eat people alive. Will John Corzine and Dick Cheney and Alan Greenspan and Robert Rubin and Tim Geithner and Barney Frank and Barack Obama go down in American history as romanticized heroes, or have we finally learned something?

This system is beyond repair; it’s a zombie financial system, and the longer it, and its zombie servants, are allowed to keep roaming the streets of our societies, the more people it will devour. And don't feel too smug thinking it won't be you next in line; what if it's one of your family members, or your friends, your neighbors?

What is it that you stand for again?

One last foray into that EU summit, courtesy of Steven Erlanger and Stephen Castle for the New York Times, that should make it all clear once and for all :

The summit meeting "will not meet the goal of creating a comprehensive firewall for the euro zone for the next three to five years," Austria’s chancellor, Werner Faymann, told lawmakers in Vienna, speaking of the effort to create a large "wall of money" in bailout funds to protect vulnerable euro zone states.

Ilargi: Did you hear that? What else do you need to know? Germany sent its heel-licking lackey Austria to deliver what news it dare not speak itself: no comprehensive firewall for years to come. A.K.A. the end of the euro.

What was achievable, however, he said, was a "massive increase in voluntary coordination," including measures to encourage greater budgetary discipline and to sanction countries running excessively high deficits.

Ilargi: The entire Eurozone project, and indeed its very failure, have been based on "voluntary coordination". Greece volunteered to dive into trillions of dollars of debt, and banks all over Europe did it to a factor of 100. And now anything voluntary would still instill confidence? Oh wait, he did say "massive increase", true. Come to think of it, given the preceding events, that just makes it all the more scarier, doesn't it?

"Get out of the way of this thing" is not just the best, but indeed all I can say. The spin doctors may come up with something on Friday that smoothes things over for a bit, but by Monday it may well be a feeding frenzy out there.

That is, unless Ben Bernanke saves the day with $5 trillion or so. In that case, it may just all be postponed until next Monday.

They can't enforce treaty changes without triggering referendums and elections, which take months to complete. They can't leverage their stability fund anywhere near the necessary level. That can't get the ECB to do it all for them. All they can do is play word games, hoping that at least someone will believe them.

And while their own voters might for a bit longer, the markets will not. Will we make it until Christmas? Hard to gauge. There's always a few more days to be bought. It's just that the cost increases all the time, and exponentially so. We won't make it in one piece for much longer than that though. Either Merkel and Sarkozy voluntarily abandon their shadow theater and go home, or the markets will force their hands.

And if they don't, the street protests will. And then the day will come when one of these 27 EU countries will elect a guy or gal based on the promise of not paying back what they "owe".

You know, as metaphors go, for far too many people it won't even be about fighting over the left over scraps swept off the bullet proof limo table; they will be on the menu. They already are, they just don't know it yet.

And in all that, something just ain't right. From where I'm sitting, at least.

Europe's banks must dispose of a pool of toxic assets larger than the entire British economy if they are to return to profitability and meet new capital rules.

Estimates from accountants Deloitte found that European banks currently hold more than £1.5 trillion of non-core and non-performing assets on their balance sheets. Deloitte said that while banks will have to dramatically shrink the size of their asset books they are likely to face major challenge in doing so given the scale of the bad loan problems they face.

British banks, despite beginning their disposal programmes much earlier than their Continental European peers, still have by far the biggest pile of toxic assets. Deloitte estimates the size of the non-core and non-performing assets held on the balance sheets of UK banks at £460bn, more than the combined total for Ireland, Spain and Italy. German banks come a close second with a toxic asset pool of about £447bn.

The implications of this for the UK economy could be severe as banks attempt to slash their exposures while trying to maintain a healthy supply of loans to business. "Unless the tension relents, credit availability to the real economy may suffer and could depress household and business confidence, resulting in less growth and fewer investment projects," warned Deloitte.

Barclays, Lloyds Banking Group and Royal Bank of Scotland have sold off more than £300bn of so-called "non-core" assets since the end of 2008, according to Morgan Stanley.

At its peak in 2008 the funding gap of the British banking system, the difference between loans and deposits, stood at £720bn, however since then banks have moved to sell off loans and raise deposits to cut their reliance on volatile wholesale funding markets. Morgan Stanley estimates that the combined non-core assets of Lloyds and RBS at £230bn, but says this will more than halve to £90bn within three years.

The most dramatic shrinkage is that of RBS, which at the time of its taxpayer rescue in October 2008 had £258bn of non-core assets, but today has less than £100bn and by 2014 is expected to have about £20bn. HSBC has also moved to run down its legacy exposures, putting its US mortgage business into run-off.

Disagreements over how to enforce better economic discipline and centralized oversight over nations in the European Union emerged on Wednesday, the day before a crucial summit meeting to deal with the euro crisis, including disputes over how extensively and how quickly to change European treaties.

French officials promised not to leave Brussels until a "powerful" deal was reached to save the euro. But senior German officials expressed more pessimism, saying that Berlin opposed a "quick fix" agreement. Instead, they insisted on full treaty changes and disagreed with the idea of combining two bailout funds, one temporary and one permanent, to create a larger pot of money to protect Italy and Spain.

Britain said that it would ask for special protections if there were any treaty changes, raising the possibility that changes would be limited to the 17 nations of the euro zone and those who want to join, and not to all 27 members of the European Union.

Still, Wednesday was a day of some posturing and public negotiating by national officials who demanded anonymity, with different nations staking out their positions before the meeting begins in earnest late Thursday afternoon. "It’s internal politics," said a senior European official. "This is macho-style, old politics."

German officials sounded the toughest, seeing this summit meeting as a chance to achieve permanent changes to the way the euro is managed, an important goal for them. The Germans want firmer debt limits and sanctions for violators written into the treaty. They prefer a treaty of all countries in the European Union, even though the changes would apply only to countries in the euro zone.

But treaty changes can take two years and could involve a referendum in Ireland and other nations, so European Union officials, wanting to move quickly, have been exploring other options. In a paper that emerged on Wednesday, the president of the European Council and of the euro zone, Herman Van Rompuy, suggested a fast-track route to a "fiscal compact" that would avoid the problems and delays of a full treaty change.

The idea laid out by Mr. Van Rompuy, who organizes the European summit meetings, would avoid a full treaty change, which could involve a convention, referendums or parliamentary ratification, but it would still achieve much of what Germany wants. This would mean amending a protocol of the treaty; leaders would simply have to consult with the European Central Bank and the European Parliament.

Under this plan, also supported by the president of the European Commission, José Manuel Barroso, leaders could ensure that countries write into their own law an obligation "to reach and maintain a balanced budget over the economic cycle." This could be complemented with pledges of "automatic reductions in expenditures, increases in taxes or a combination of both" if the rule was broken.

Britain insisted that such an amendment would still require at least parliamentary ratification, and a senior German official, briefing reporters, decried the quick fix as "a typical Brussels bag of tricks" and a "rotten compromise."

More fundamental changes that would assure fully automatic sanctions against budget sinners, and give European institutions the power to overrule national budgets, would require full treaty change.

The German official said he was "more pessimistic than last week about reaching an overall deal," adding, "A lot of the protagonists still have not understood how serious the situation is." Berlin’s idea appeared to be to increase the pressure on partners to come to terms that Germany favored.

The American Treasury secretary, Timothy F. Geithner, was building the pressure in a softer way on Wednesday. He continued his public tour of meetings with German, French and Italian leaders to underscore how important reaching a deal this week was to the Obama administration. The administration says it believes that the euro zone crisis is dragging down the global and the American economy and could cause another full-fledged banking crisis.

But one senior European official said that an answer might be a "two-phase solution," with a quick change to the protocol followed by work on treaty change. European officials say that a less ambitious but faster strengthening of euro zone discipline will be more credible with investors and the European Central Bank than the promise to make larger reforms that could take two years to put into place.

As one French official said Wednesday, "The E.C.B. is not going to commit suicide" and oversee the destruction of the euro currency it is charged with keeping stable.But Austria, like Germany, also tried to play down expectations for a "quick fix" solution to the euro crisis.

The summit meeting "will not meet the goal of creating a comprehensive firewall for the euro zone for the next three to five years," Austria’s chancellor, Werner Faymann, told lawmakers in Vienna, speaking of the effort to create a large "wall of money" in bailout funds to protect vulnerable euro zone states.

What was achievable, however, he said, was a "massive increase in voluntary coordination," including measures to encourage greater budgetary discipline and to sanction countries running excessively high deficits.

The Americans have regularly counseled using ready bailout money as a firewall in the crisis. But it has not been easy for the Europeans, as they have tried to leverage a temporary, 440-billion-euro European Financial Stability Facility upward. One French-German idea is to move forward, to 2012, the establishment of the larger, permanent 500-billion-euro European Stability Mechanism. But Berlin is rejecting the idea of running the two in parallel.

The Europeans are also talking to the International Monetary Fund, where Washington has the largest voice, about helping to enlarge the firewall with money that the European central banks could loan to the fund. An announcement is also expected late Thursday on how European banks would comply with the tougher capital requirements.

The immediate eurozone crisis cannot be solved by punishment measures alone. There needs to be some form of joint debt issuance and a lender of last resort to halt "systemic stress".It was well-timed to drop this bombshell on Monday night after the Merkozy fudge (though S&P made the decision earlier), since the duumvirate yet again failed to offer any meaningful way out of the impasse.

"Policymakers appear to have acted only in response to mounting market pressures, rather than pro-actively leading market expectations in a way that might have better supported and strengthened investor confidence. We take the view that the defensive and piecemeal nature of this response has helped expand the crisis of confidence in the eurozone." Spot on.

IMF chief Christine Lagarde was equally dismissive of the Merkozy plan. "It’s not in itself sufficient and a lot more will be needed for the overall situation to be properly addressed and for confidence to return."

As S&P states, a credit crunch is taking hold, partly because of the EU’s pro-cyclical demands for higher capital ratios. Euroland’s incoherent mix of policies are pushing the eurozone into recession and therefore into deeper debt stress. "As the European economy slows, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, eroding the revenue side of national budgets."

There has of course been consternation in Germany, usually based on a misunderstanding of how rating agencies operate. They measure default risk, therefore members of a fixed currency union are inherently more risky.

The US and the UK have used QE to inflate away some of the debt, and they have weakened currencies to act as a shock absorber. This is undoubtedly a form of stealth default, but that is not what S&P measures. It deals only with "credit events", and such an event is less likely for countries with a sovereign currency and central bank that can inflate (provided their debts are in their own currency).

Furthermore, shrieking Europols commit the fallacy of comparing levels of public debt and deficit levels with the US. That evades the core problem, that the eurozone’s banking nexus is €23 trillion, or three times sovereign debt. This has become a contingent liability of the governments themselves, especially the AAA core.

"For countries in net external liability positions, including the eurozone’s peripheral economies, we see growing risks to the funding of their external requirements. In our view, financial institutions located in countries in net external asset positions (such as Germany) also face pressure where the quality of those assets is deteriorating.

Deleveraging by European banks is intensifying, as they reduce their balance sheets amid worsening funding conditions, look to bolster their capital ratios, and address concerns about deteriorating asset quality among their borrowers. By our estimates, a sample of 53 large eurozone banks from 12 countries will face bond market maturities of an historic record of over 205 billion euro in the first quarter of 2012."

I might add that EMU banks have a loan-to-deposit ratio of almost 1.2 (like Japan before the Nikkei bubble burst), compared to 0.7 in the US. They are much larger in aggregate, much more leveraged, and mostly underwater already on EMU bonds if forced to mark to market. In essence, the whole eurozone is already insolvent. Face up to it.

(Yes, yes, before you all scream over there, Britain is insolvent too by the same yardstick. That is why it is useful to have the magical instrument of a sovereign central bank in such circumstances – and one willing to act – to conjure away the awful truth.)

Euroland’s crisis is not about Greek pensions or Italian labour laws, but about a vast and catastrophically ill-designed edifice of interlocking bank debt and sovereign debt. You cannot separate the two. The sovereigns are destroying banks, and the banks in turn are destroying sovereigns. The two disasters are feeding on each other. This will continue until there is a circuit-breaker, both to act as lender of last resort and to end the slump.

S&P does not pull its punches on this: "We will analyze the policy settings of the ECB to address the economic and financial stresses now being experienced by eurozone sovereigns. In particular, we will examine the potential impact these policy settings will have in both staunching the eurozone’s increasing output gap and ameliorating its currently dislocated debt markets."

In other words, Europe has been told that the ECB’s contractionary policies – if continued – will lead to downgrades. The agency is targeting the output gap. The Europeans are entitled to ignore this as – in their view – the worst sort of New Keynesian and Anglo-Saxon muddled thinking. Fine, but you can hardly complain if you lose your AAAs from an Anglo-Saxon New Keynesian agency.

Take it on the chin, defy the world, and pursue your 1930s policies if you wish.

Europe's banks urgently need fresh capital to meet tougher EU rules, but they will have problems raising it amid the current crisis of confidence plaguing the euro zone. The survival of Commerzbank, Germany's second-largest bank, is at stake, and Berlin is considering a full nationalization of the bank if necessary.

In the foyer of Frankfurt's Commerzbank Tower stands a Christmas tree decorated with all manner of glitter. The idea is to brighten up the gloomy mood with a bit of seasonal cheer. Next to the tree is a notice board covered with children's wish lists for the Yuletide. Most of the youngsters want computer games and other forms of amusement -- small wishes, for the most part, that can easily be fulfilled.

t will be more difficult to indulge the man sitting on the 48th floor of the building. If Commerzbank CEO Martin Blessing could make one wish, he would presumably ask for a few billion euros, or that someone would take the bank's ailing subsidiary Eurohypo off his hands, or that the entire sovereign debt crisis would simply disappear.

But banks, along with their managers and owners, are not allowed to pin their hopes on miracles. They need money, as quickly as possible. And since Commerzbank's survival is at stake once again, the major shareholder in Berlin is thinking the unthinkable: One-quarter of Germany's second-largest financial institution already belongs to the state; now the government is considering fully nationalizing the bank if necessary.

According to government sources, if Commerzbank doesn't manage to raise sufficient capital on its own by next summer, Berlin will reactivate the Special Fund for Financial Market Stabilization (Soffin) and purchase additional shares in the bank. The sources say that they assume the government would acquire a majority of the bank's shares in a capital increase.

But things haven't reached that stage yet -- and they won't necessarily have to, either. Commerzbank management is working round the clock to solve the problem without government aid. It's a difficult job that will mainly have to be tackled by the new Chief financial Officer, Stephan Engels, who was appointed by the supervisory board last Friday.

If Commerzbank fails to meet the challenge, though, Blessing's days at the head of the commercial lending giant may very well be numbered. "I'm not going there again," he recently said, in reference to a government bailout of €16.2 billion ($21.7 billion) that the bank received in 2009. His statement was not well received in Berlin.

Euro Crisis Management Has Hit BanksRelations between politicians and the financial industry are already extremely strained. Bank managers say that the ballooning debts of a number of euro-zone countries are to blame for this renewed banking crisis only three years after the collapse of Lehman Brothers -- and they contend that the crisis management pursued by Brussels, Berlin and Paris has merely exacerbated the problem.

First, the heads of government in the euro-zone pressured their banks to waive a portion of Greece's debts. Then the EU imposed new, stricter capital requirements on financial institutions. By the end of June 2012, European banks will have to raise their core capital ratios to at least nine percent.

The fate of the lending institutions now depends more than ever on how the crisis develops. What's more, "Commerzbank is the clinical thermometer for the euro crisis," said one insider. Financial market players doubt that the euro member countries can get their debt problems under control -- and since the banks have invested heavily in government bonds, investors also mistrust the banks.

True, the world's leading central banks provided some relief to lenders last week. They showered the increasingly dry financial system with cheap money. But the flood of cash has not removed the causes of the crisis. The banks will only stabilize when investors regain trust in their stability.

It's hoped that the stress test and the new capital requirements introduced by the EU and its regulatory agency, the European Banking Authority (EBA), will achieve just that. After weeks of wrangling, the regulators have apparently agreed to a compromise; exact figures are expected to be presented this week.

According to sources within the agency, the regulations will be much tougher than what the EBA announced in October. European banks could require up to €200 billion in fresh capital, with the Germans alone needing €10 billion. Commerzbank is likely to account for approximately €5 billion of this, and Deutsche Bank for nearly €3 billion.

Where is the money supposed to come from? "It's a mystery to me how some banks can be expected to meet the higher capital requirements at such short notice," says bank expert Michael Göttgens from the auditing and consulting company Deloitte.

The traditional way would be to raise capital by issuing new shares on the stock exchange. Investors, though, are avoiding European bank stocks precisely because of the sovereign debt crisis. To make matters worse, financial institutions will probably also generate lower returns over the long term due to the more stringent regulatory demands.

Only Italy's largest bank, Unicredit, and Austria's Raiffeisen Bank have dared to announce significant capital increases. Unicredit, which owns Germany's HypoVereinsbank, intends to raise €7.5 billion -- although it recently made a loss of €10 billion in just one quarter.

Scaling Down LoansThe Italian Securities and Exchange Commission (CONSOB) is making a stand against the EBA, which is headed by an Italian, Andrea Enria. CONSOB is afraid that the strict regulations for financial institutions will strangle the Italian economy. In effect, so the argument goes, banks can also increase their capital ratios by reducing their balance sheets -- in other words, by granting fewer loans.

This is also the approach that Commerzbank is likely to take. Industry insiders calculate that the bank could free up some €3 billion in capital by allowing loans and bonds to mature without renewal. Since such transactions have to be backed by equity capital, this would reduce the demand for fresh capital.

However, banks that scale back their operations also pass up opportunities for profits. "It's alarming if Commerzbank has to significantly reduce its volume of business," says a member of the supervisory board. It's not enough, though, for the bank merely to refrain from conducting new business -- it would also have to sell off loan portfolios.

Other banks are considering this as well. This could revive a business that had been pronounced dead after the Lehman crisis: Risks that can't easily be reduced are simply sorted out and sold.

"Regulatory capital relief trades" is the term for the deals that are currently coming into fashion among European banks. This involves, for instance, taking loan packages apart and reassembling them according to risk classes.

Elements that entail a particularly high risk of financial loss end up in so-called junior tranches. Banks have to retain an extremely high amount of capital to cover such high-risk bundles. Nevertheless, when converted to securitized investments, banking sector regulations allow for 95 percent of such unwanted packages to be written off the books.

Buyers of such products include US banks, which don't have to adhere to the same equity regulations as European lenders. It's primarily hedge funds, though, that seize upon such opportunities and cash in on fat interest rates.

As long as everything goes smoothly, the deals are worthwhile for everyone involved. Yet such transactions merely shuffle the risk back and forth, says Merck Finck analyst Konrad Becker. "This runs contrary to the goal of making the financial system more secure by introducing stricter equity capital regulations for banks."

Whether such credit swaps will swiftly help the banks out of their predicament is debatable anyway. Indeed, on Friday Commerzbank executives presented the supervisory board with additional ideas to bolster their capital reserves. For example, the board of directors wants to retain profits rather than distribute them.

But there are two problems with this: First, the bank recently drifted into the red; second, shareholders don't like their dividends being scrapped. This in turn compounds the difficulties of winning over shareholders for a capital increase.

Commerzbank Mulling Radical MeasuresNevertheless, all of these efforts could ultimately prove insufficient. This realization has prompted government experts in Berlin, as well as in the bank, to examine even more radical ideas.

A top priority is finding a solution for the ailing subsidiary Eurohypo, which holds the shaky sovereign bonds. "As long as Commerzbank fails to get rid of the Eurohypo problem, it won't be able to raise any capital on the market," says an investment banker. The commercial lender is highly unlikely, though, to find a private buyer for Eurohypo. Banks are currently seen as practically unsellable.

Wouldn't it make sense then to hand Eurohypo to the German government? It could pool the toxic assets in a bad bank, allowing Commerzbank to face a brighter future, freed of this burden.

However, it seems very unlikely that Berlin would go along with this. "The state is not a dumping ground for the private economy," says Volker Wissing, the deputy parliamentary leader of Chancellor Angela Merkel's junior coalition partners, the pro-business Free Democratic Party (FDP).

He also argues that handing Eurohypo to the German government could trigger a new round of state aid investigations. The arbitrary assumptions of a stress test cannot justify decisions that burden taxpayers, says Carsten Schneider, a finance expert for the center-left opposition Social Democrats (SPD). "If capital is needed, then it should be raised through common stock and without dubious compromises."

Investment bankers say that if the bank were nationalized, it would be possible to hive off Eurohypo and subsequently sell off the healthy remainder of Commerzbank. The proceeds could then be used to balance out any losses sustained from Eurohypo.

Politicians in Berlin express only muted enthusiasm for such a bailout scheme. "The parliamentarians don't want yet another bank that will become a source of political dispute," says one Commerzbank manager. This reluctance is understandable.

The MPs still vividly remember a similar situation with Hypo Real Estate: In 2009, the German government took full control of this ailing group of real estate financing banks and split off the riskiest investments into a bad bank. But it still remains totally unclear exactly how much money taxpayers lost during the deal.

The Berlin government and Commerzbank have one Christmas wish in common: that the euro debt crisis doesn't bring down Italy, which would put governments and banks under even greater strain. Cynics, however, would add: If Italy defaults on its loans, the euro crisis will reach such dimensions that Commerzbank's problems will be negligible by comparison.

Wide variations in the way banks measure the riskiness of their assets could undercut global efforts to make the financial system safer, UK and European Union regulators are warning.

Risk weighted assets form the denominator of the basic measure of bank safety – the core tier one capital ratio – and there is growing concern that some banks may be tinkering with the way they measure the riskiness of their assets in order to boost their reported ratios.

The UK’s new stability regulator, the Financial Policy Committee, said in minutes released on Tuesday that the models banks use to calculate their RWA are "opaque to investors and regulators ... [and] could have dented market confidence."

It decreed that UK banks should start making public their "leverage ratio" – an alternative measure of bank safety that relies on total assets without risk adjustments – in 2013, and promised to return to the subject at future meetings.

In Brussels, Andrea Enria, head of the European Banking Authority, which oversees regulators in the 27-nation bloc, raised even stronger concerns about RWA in a speech on Monday night, saying that national and institution-by-institution differences are undermining efforts to strengthen the region’s banks.

"Higher capital requirements in one country might turn out to be more lenient if the technical application is based on laxer approaches. Without a single rule book ... we are bound to work without a real level playing field."

Both the EBA and the Basel Committee for Banking Supervision, which sets global rules, are looking at the way banks measure risk, with an eye to adding more standardisation. Some bankers have raised similar concerns, including the chief executives of JPMorgan Chase and Santander.

The FPC minutes also offered the strongest indication yet that UK regulators will force banks in London to curb their pay-outs to employees this year, saying that the body "saw a strong case for limiting distributions to staff, although this might not be costless."

The committee also urged UK banks to consider raising additional capital. "The committee recognised there were risks associated with attempting to raise fresh external capital in a stressed market environment. On balance, members judged these concerns were outweighed by the benefits ... to the resilience of the system as a whole."

On November 29, 2011, Bloomberg Magazine's Richard Teitelbaum published an article revealing a secret meeting on July 21, 2008, with then Secretary of the Treasury and former Goldman Sachs CEO Hank Paulson and around a dozen hedge-fund managers and Wall Street executives.

Five of the hedge fund managers were former Goldman Sachs employees. The meeting was held at the offices of the founder of hedge fund Eton Park Capital Management, Eric Mindich, a former 15-year employee of Goldman Sachs who rose to be the senior strategy officer of Goldman's Executive Office. He is also current Chair of the Asset Managers' Committee of the President's Working Group on Capital Markets.

Then Secretary Paulson asked the hedge fund managers what the market might think if he placed mortgage giants Fannie Mae and Freddie Mac into conservatorship, a move that would have wiped out value for the shareholders and possibly wiped out value for subordinated debt holders.

According to the article, one hedge fund manager had a short position in these stocks when he walked into the meeting. He was shocked that Secretary Paulson blabbed specifics, and the hedge fund managers therefore believed the Treasury Department would implement the plan. Seven weeks later, it did.

The hedge fund manager called his lawyer at a break in the meeting, and his lawyer told him Paulson had divulged non-public material information. His lawyer advised him to stop trading in the shares of these companies immediately. Ironically, that meant the hedge fund manager could not cover his short positions, so he profited by riding the value of the shares all the way down to the bottom. If he hadn't been at the meeting, and if he had any doubts, he might have covered his short position earlier and made less money. One will never know, because Secretary Paulson tied the hedge fund manager's hands.

But the more interesting implication is for the other managers in attendance. If they didn't already have a short position in Fannie Mae and Freddie Mac, they now had non-public material information that would allow them to almost certainly profit mightily by initiating such a trade. They could even be more confident in shorting other financial institutions that would likely take a shellacking.

Richard Teitelbaum quoted me: "What is this but crony capitalism? Most people have had their fill of it."

Meanwhile, then Secretary Paulson told the public a different story than he told the meeting attendees. According to Bloomberg's research, earlier that day, Paulson told the New York Times that the Federal Reserve and the Office of the Comptroller of the Currency were inspecting Fannie and Freddie's books and he expected the result of this would inspire confidence. The Times's article appeared the following day. Any investor in the shares of Fannie and Freddie would be less likely to sell their shares in the face of this reassuring message.

There is no way of knowing whether the hedge fund managers initiated new trades as a result of this meeting, but the key issue is that then Secretary of the Treasury Paulson communicated non-public material information that could financially benefit the recipients at the public's expense.

Apparent Damage Control: That's How They RollOn Wednesday, November 30, 2011, I got a call from a staffer for Congressman Michael Quigley (D., IL.). Congressman Quigley represents Illinois's 5th district. He replaced Rahm Emanuel, the current Mayor of Chicago, in a special election after Rahm resigned to become White House Chief of Staff. Rod Blagojevich preceded Rahm Emanuel. Blagojevich was elected Governor in 2002 and was subsequently impeached for corruption and misconduct and convicted of one count of lying to the FBI. He awaits sentencing.

Congressman Quigley's staffer called because he saw my quote in the Bloomberg article. He claimed he was looking for clarification of my position, and I stated the article accurately reflected my viewpoint. But the staffer seemed to me to defend the meeting.

The staffer said this kind of meeting "happens all the time." I retorted: "Really? What's the excuse?"

He then claimed he was just trying to play "devil's advocate." But don't we have a surplus of those?

The staffer claimed that people want to discuss regulations with people who might be affected. I responded that this excuse is ludicrous. Then Secretary of the Treasury Paulson discussed material non-public information about the restructuring of Fannie Mae and Freddie Mac with people who were in a position to profit at the expense of the public. I cut the phone call short at that point.

I would like to give my local politician the benefit of the doubt that a staffer wasn't acting as an errand boy trying to send a message, but that phone call didn't give me much to work with. It seems that whether it's Henry Paulson working for a Republican administration or a Democratic errand boy doing apparent damage control, it looks as if we're steeped in bi-partisan sleaze. If the staffer was merely playing the fool, then U.S. citizens needn't suffer them gladly.

Breach of Then Treasury Secretary Paulson's Duty as a Public StewardThis is from the Department of Treasury's web site: "Treasury's mission highlights its role as the steward of U.S. economic and financial systems, and as an influential participant in the world economy."

It seems to me that the Secretary of the Treasury is a civil servant and a public steward. When then Secretary Paulson offered material non-public information to hedge fund managers that could profit by trading shares (initiating new shorts) of Fannie Mae and Freddie Mac while telling the public a different story, he breached those duties.

Public service is just a social contract, and as one fund manager observed: "so are the Ten Commandments."

What do we, as Americans, stand for and how much of this can we stand? What are we willing to tolerate or not tolerate from our public servants? Where did we go so wrong that Congressional staffers--most probably errand boys--imply that crony capitalism is business as usual?

In case our politicians or their staffers may have any remaining questions, let me be clear.

The Bank of France faces surging debts to Germany's Bundesbank and fellow central banks in the EMU system as foreign investors pull large sums out of French accounts.

French lenders lost €100bn (£86bn) in short-term deposits in September alone, mostly due to precautionary moves by US money market funds and Asian investors afraid of France's exposure to Italy. "There were huge net capital outflows," said Eric Dor from the IESEG School of Management in Lille.

The effects of this capital flight are surfacing on the Bank of France's books under the European Central Bank's so-called "Target2" scheme, an ECB payment network that lets funds move automatically where needed. Liabilities jumped suddenly in late July, rising from €10bn to €98bn by September. Ireland's central bank owes €118bn, Spain's €108bn and Italy's €89bn.

The triple-trigger appears to have been a sudden drop in Club Med manufacturing orders, an ECB rate rise, and the EU's July summit – which led to haircuts on Greek bondholders and battered faith in EMU sovereign debt. Mr Dor said there had been an exodus from distressed states into German, Dutch and Luxembourg banks. This shows up in the Target2 data.

While the liabilities can in theory keep rising for ever within EMU, they signal grave imbalances, such as the North-South trade gap so long ignored until it proved fatal. They ultimately leave debtor central banks deep under water if the eurozone breaks up. "We are in unknown territory in terms of monetary theory," said Mr Dor.

On the creditor side, the Bundesbank is left holding €465bn in IOUs, and the Dutch central bank €89bn, stoking fears that these countries could suffer a big loss if EU leaders fail to contain the crisis. The national central banks are also on the hook for the ECB's other operations.

Simon Ward from Henderson Global Investors said ECB support has jumped by €465bn since April, with a sharp rise of €102bn over the last four weeks. The total exceeds €1.3 trillion, or 4.5pc of eurozone GDP.

It includes "repo" loans to eurozone banks, as well as emergency liquidity assistance (ELA) to Greece and Ireland, and bond purchases. The nexus of liabilities would be a nightmare to unscramble.

Better late than never. Standard & Poor's has been slow to recognise the default risk for states that give up their central bank in a currency union. Bond vigilantes have forced action.

The agency is right to warn that Euroland's immediate crisis cannot be halted only by policing budgets. There must be debt pooling and a lender of last resort to stop "systemic stress". The cannon shot across Europe's AAA creditors is a cold reminder that they too are part of the mess. It is well-timed, coming hours after Merkozy again failed to offer any meaningful way out of the impasse.

"Policymakers appear to have acted only in response to mounting market pressures, rather than pro-actively leading market expectations in a way that might have better strengthened investor confidence. The piecemeal nature of this response has helped expand the crisis of confidence in the eurozone," it said.

Christine Lagarde, the International Monetary Fund's chief, was equally dismissive of the Merkozy plan. "It's not in itself sufficient and a lot more will be needed for confidence to return," she said.

The rating agency said a credit crunch is taking hold. Euroland's policies of synchronized fiscal and monetary contraction have pushed the region into recession, and therefore into deeper debt stress. "As the European economy slows, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating."

Luxembourg's premier Jean-Claude Juncker called the move "completely over the top and unfair", insisting that Europe is "on the way to solving the debt crisis."

Claims by some that S&P is waging currency warfare are absurd. The agency has stripped America of its AAA. France is in worse shape on the same metrics, including with pension liabilities.

There is much confusion over how rating agencies operate. They measure default risk. The US and the UK have used QE to inflate away debt. This may be stealth default, but S&P deals only with "credit events". These are is less likely for countries with their own central bank that can backstop public debt in a crisis.

The eurozone's combined debts and deficits are lower than the US, but its €23 trillion (£19.7 trillion) banking nexus - three times sovereign debt - is greater. This is a contingent liability. Eurozone banks have a loan-to-deposit ratio of 1.2, compared to 0.7 in the US. They are much larger, more leveraged, and mostly underwater on EMU bonds if forced to mark to market.

The threat in Euroland comes from a vast edifice of interlocking bank debt and sovereign debt. Each is destroying the other. This will continue until there is a circuit-breaker.

The agency calls on the ECB to act, both a last-resort lender and to halt the slump. "We will analyse the policy settings of the ECB to address the economic and financial stresses now being experienced by eurozone sovereigns.... and in staunching the eurozone's increasing output gap." In other words, there will be downgrades if the ECB sticks to 1930s policies. It may not be a currency war, but it is a war of economic ideas.

Many Greeks are draining their savings accounts because they are out of work, face rising taxes or are afraid the country will be forced to leave the euro zone. By withdrawing money, they are forcing banks to scale back their lending -- and are inadvertently making the recession even worse.

Georgios Provopoulos, the governor of the central bank of Greece, is a man of statistics, and they speak a clear language. "In September and October, savings and time deposits fell by a further 13 to 14 billion euros. In the first 10 days of November the decline continued on a large scale," he recently told the economic affairs committee of the Greek parliament.

With disarming honesty, the central banker explained to the lawmakers why the Greek economy isn't managing to recover from a recession that has gone on for three years now: "Our banking system lacks the scope to finance growth."

He means that the outflow of funds from Greek bank accounts has been accelerating rapidly. At the start of 2010, savings and time deposits held by private households in Greece totalled €237.7 billion -- by the end of 2011, they had fallen by €49 billion. Since then, the decline has been gaining momentum. Savings fell by a further €5.4 billion in September and by an estimated €8.5 billion in October -- the biggest monthly outflow of funds since the start of the debt crisis in late 2009.

The raid on bank accounts stems from deep uncertainty in Greek households which culminated in early November during the political turmoil that followed the announcement by then-Prime Minister Georgios Papandreou of a referendum on the second Greek bailout package.

Papandreou withdrew the plan and stepped down following an outcry among other European leaders against the referendum, and a new government was formed on Nov. 11 under former central banker Loukas Papademos. That appears to have slowed the drop in bank savings, at least for the time being.

Bank Withdrawals Worsening CrisisNevertheless, the Greeks today only have €170 billion in savings -- almost 30 percent less than at the start of 2010.

The hemorrhaging of bank savings has had a disastrous impact on the economy. Many companies have had to tap into their reserves during the recession because banks have become more reluctant to lend. More Greek families are now living off their savings because they have lost their jobs or have had their salaries or pensions cut.

In August, unemployment reached 18.4 percent. Many Greeks now hoard their savings in their homes because they are worried the banking system may collapse. Those who can are trying to shift their funds abroad. The Greek central bank estimates that around a fifth of the deposits withdrawn have been moved out of the country. "There is a lot of uncertainty," says Panagiotis Nikoloudis, president of the National Agency for Combating Money Laundering.

The banks are exploiting that insecurity. "They are asking their customers whether they wouldn't rather invest their money in Liechtenstein, Switzerland or Germany."

Nikoloudis has detected a further trend. At first, it was just a few people trying to withdraw large sums of money. Now it's large numbers of people moving small sums. Ypatia K., a 55-year-old bank worker from Athens, can confirm that. "The customers, especially small savers, have recently been withdrawing sums of €3,000, €4,000 or €5,000. That was panic," she said. Marina S., a 74-year-old widow from Athens, said she has to be extra careful with money these days. "I have no choice but to withdraw money from my savings," she said.

Bad LoansThe shrinking Greek bank deposits compare with bank loans totalling €253 million. Analysts say the share of bad loans could rise to 20 percent next year, or €50 billion, as a result of the recession. This in turn will worsen the already pressing liquidity problems faced by Greek banks.

Nikos B., a doctor in the Greek military, has had enough of the never-ending crisis his country is going through. While the 31-year-old has a secure job, repeated salary cuts have made it increasingly hard for him to make ends meet.

He needs most of his money to make loan repayments for a small car. "How can I clear my account? There's hardly anything in it," he says. He started learning German two months ago and wants to leave Greece. "As soon as possible!" Nikos pauses and looks down. He quietly utters words that must be painful for a proud Greek. "It would be best to change nationality."

GermanyThe euro crisis is boiling down to one key question: is Germany trying to rule Europe? Angela Merkel insists not, telling MPs last week that such an idea was "absurd". Nonetheless, on Tuesday an op-ed in Europe's best-selling newspaper, Bild, suggested the chancellor should be leading more and not less.

"Germany is learning how to lead in Europe – about time too," wrote Nikolaus Blome in the 3m-circulation tabloid. He dismissed as "cheap shots" much of the criticism of Merkel. "Whenever the chancellor doesn't rock the boat she is accused of 'weak leadership'. And when she – with France – tries to take the lead, she is accused of 'sabre rattling'."

The latter accusation – Kraftmeierei in German, which can also be translated as "bluster" or "swagger" – was thrown at her earlier this week by Helmut Schmidt, the revered former chancellor from the opposition SPD party. He said what Europe needed from Germany was solidarity and understanding rather than muscle-flexing.

One businessman complained in the Süddeutsche Zeitung broadsheet that Merkel's plans for a fiscal union were too lily-livered. "United States of Europe? It's not enough!" ran the headline of a piece by Christian von Bechtolsheim, from the wealth managers Focam. Germany should be the EU's role model, he said, not the USA. A particular inspiration, he said, should be the Länderfinanzausgleich – Germany's "unfairly criticised" way of redistributing wealth from the country's rich south to prop up the ailing eastern states.

FranceThose kind of sentiments might not go down too well in elsewhere in Europe.

Jean-Charles Noudell winced as he took his terrier for a morning walk past news-stands showing pictures of the happy "Merkozy" marriage. The French president and German chancellor grinned from the front pages, having agreed their new European treaty plan to protect the euro. French papers hailed the "historic compromise" as good news for Europe.

"But it's politicians just trying to pull the wool over our eyes again, isn't it? It won't change the black mood of pessimism in France, people can't afford their bills, salaries have stagnated, the economy's crocked," said Noudell, a Paris park keeper.

Pundits talk of France becoming a bit more German – balancing their budgets for the first time in 35 years – but not too German. But the debate has focused on how much Merkel has railroaded Paris into accepting her conditions.

"Germany is a country that always wanted to lead, a country of conquerors, a proud country which won't accept merely following behind. They've been stuck behind others since the war and now they'll do anything to be on top," said Noudell, who observed that Germany was not a model in everything – "its parks are a mess".

The debate in France has been tinged by a row over Germanophobia. French Socialists oppose the Sarkozy-Merkel deal on the grounds that a new European treaty would take too long to ratify and does not address how France actually deals with its troubled public finances. Accused by the right of "dangerous Germanophobia", key Socialists such as Arnaud Montebourg are unrepentant over comments complaining of German "nationalism" and likening Merkel to Bismarck, autocratic unifier of Germany.

In France, the timing of Sarkozy's treaty plan is crucial: presidential elections in less than six months (hence Sarkozy's talk of "fear" and "urgency" as opposed to Merkel's drive for slower, long-term solutions) and a very real fear of losing the coveted triple-A credit-rating.

Sarkozy has been trying to push through his austerity measures by telling France, which fiercely defends its social model, that it must be more like Germany. Now with tax harmonisation a very real possibility, French papers list comparisons with its economic powerhouse neighbour: Germany has lower unemployment but no minimum wage, lower taxes on business but marginally higher on individuals, lower public debt than France but more poverty.

On the street, the feeling is Sarkozy still has far to go to sell the treaty to a population sceptical of his policies at home and distrustful of economics. "This won't change the real mood of anger in France, particularly outside Paris," said Laurent Betremieux, an artist. "Both Sarkozy and Merkel are still propping up a capitalist system and the markets who are making money out of this crisis. The mood here is so desperate that if something sparked people to take to the streets together, you feel there could be a revolution."

IrelandIn Finglas, a working-class suburb of north Dublin, there were rumours swirling around that the Irish state was reprinting the defunct Irish punt just in case the euro collapsed.

the indicators of economic hardship are everywhere with shops and pubs boarded up, only a trickle of shoppers braving the freezing temperatures and sale signs everywhere. Outside Connolly's fish shop, Siobhan Aspell wondered if the old currency everyone thought was dead and buried would have to be resurrected.

"The way this country is going I suppose anything could happen," she said as a pair of pensioners shivered in the December cold. "Surely we have lost our independence anyway but I wouldn't be surprised if the punt came back. It's hard to imagine it but at least it would mean we could control our interest rates." If Friday's crucial EU summit resulted in a fresh European treaty, Aspell said she would vote against it this time.

"Do I want the Germans to have more power over us? No. I would vote against even though Irish people are afraid."

Reflecting that fear and uncertainty given the latest austerity budget and the seemingly never ending recession, Aspell said many of her customers had lost faith that the EU would continue to shore up the Irish banking system, which has absorbed billions of Irish and European taxpayers' money.

"There is a man who comes into this shop every Saturday morning whose wife recently passed away. When he was going through his house after her death he found thousands of euros under the mattress, in tins and boxes because she didn't trust the banks."

Huddled near a kebab shop with Perry Como's Christmas songs booming from a PA across the drab commercial centre of the village, Ken Murphy was resigned to the Germans getting their way. "My instinct is to say no and say she [Angela Merkel] should not get her way. We will definitely lose more of what's left of our sovereignty. Personally, if there was another referendum I would vote against the EU now and even the euro. We are losing too much as it is."

So what about another alternative – to rejoin sterling and tie the Irish economy closer than ever to the UK? "I don't know if I'd accept the English pound to be honest. We would still have to our currency but I think the majority of Irish people are resigned to the big powers like Germany getting their way."

Inside Dolan's butchers, a business that has been based in the village for four decades, Michael Dolan was stoical about Ireland ceding more economic independence to an increasingly German-dominated EU. "He who pays the piper calls the tune," the surprisingly jovial butcher remarked. "Whatever they [the Germans] want, once they throw a few euros under our door we will vote for anything."

Dolan said he would not vote in any possible new referendum but accepted that the Irish would eventually have to acquiesce to German demands.

"We needed the money the Germans gave us the money to pay our police, nurses, civil servants so she [Merkel] will get her way. Ireland is borrowing millions per week to pay for our public services. Where is that money coming from? It's not flowing from the tax revenues here in Ireland. If we are honest, we could not afford all those services and pay the wages of those people without the Germans."

He sounded one note of resistance regarding Ireland's low corporation tax which at 12.5% is regarded as one of the main enticements for foreign direct investment setting up in the Republic. "If Mr Sarkozy got his way and we had to give up the low corporation tax, then all the multinationals would leave Ireland. Now that would be going too far," Dolan added.

SpainThere is resignation too in, where There may be just four frantic days left to save the euro, but the streets of major cities fell silent yesterday as relaxed Spaniards shut their eyes to austerity and took much of the week off. There may be just four frantic days left to save the euro but two days this week are public holidays, bringing the country to a halt.

Tuesday's holiday to mark the constitution and Thursday's rest day to mark the Immaculate Conception mean that . Many people take an extra day or two (or three) off to turn the week into what is called a "bridge" or a "viaduct" holiday. Many factories and offices, along with some public services, have closed – just as Spain's economy dips into a second recession in three years.

While Spain rests, however, its future will be decided elsewhere – culminating in the EU leaders' summit on Friday. Like the rest of southern Europe, it expects to be told to impose even greater austerity on an already suffering economy.

"We are in a 'bridge' week and so we won't even be aware of how our future is being decided," said Iñaki Gabilondo, a commentator for the Prisa media group. "But we citizens already have the impression that we don't really count that much."Some Spanish factories close for all of the December "viaduct" week, as it is not viable to stop and restart production so many times during the week – especially when many workers want to take extra holiday days.

Schools in many regions take their own "bridge" holiday by making Friday a school holiday – and forcing parents to take that day off as well. Government offices and small businesses often also grind to a halt. Employers and austerity campaigners want British-style bank holidays on Mondays, saying that will help the country boost productivity and start growing again.

"The 'bridge' holiday in December is a complete scandal," said Joan Rosell, head of the country's employers' association. It claims that, if the economy closes down completely, the week's holiday could cost the country more than €1bn, or one percent of GDP.Among other dates Rosell wants moved are some that, for varying reasons, Spaniards consider sacred. They include the traditional Christmas gift-giving day of Epiphany on 6 January, along with Easter Thursday and the May day labour holiday.

A study by the Randstad employment agency reveals that 70% of Spaniards would be happy to move some public holidays to Mondays. Spain's holiday week coincides with a period of government stagnation. Mariano Rajoy led his conservative People's party (PP) to victory at a general election on 20 November, ousting the socialists of prime minister José Luis Rodríguez Zapatero.

Rajoy has promised yet more austerity, but will have no voice in the EU meeting on Friday. Regional governments run by his party have already signalled that they will lower civil service salaries and increase the length of working days next year.

PolandPoland, a nation partitioned for 123 years only to fall under Soviet control for another half-century, is understandably concerned about closer integration within the EU. Radosaw Sikorski, foreign minister, caused uproar last week when he called in Berlin for closer ties, specifically appealing for Germany to lead and saying he "feared German power less than German inactivity".

Poland is the biggest mainland EU country not in the euro but Sikorski said Poland would fulfil the criteria for monetary union by 2015 and "planned to join" despite its manifest problems. The prime minister, Donald Tusk, and President Bronisaw Komorowski both support Sikorski's ideas.

Ordinary people are not so sanguine. A recent poll showed that 53% of Poles think joining the eurozone would be disadvantageous for the country and Sikorski's big picture view of Poland's position in Europe has not been well received – the conservative opposition who have accused him of "longing for the Fourth Reich".

"Both sides are playing on emotions. It is easier to throw around words like sovereignty and independence when in actual fact it is very difficult to explain those notions in today's inter-dependent world," said Sergiusz Trzeciak, author of the book Poland's EU accession. He said he does not think most Poles will buy the conservative line but many are still sceptical of German leadership in Europe.

Adam Winiarski, 32, a secondary school teacher who lives in Warsaw, said: "It is outrageous that a Polish minister should be publicly weighing the idea of renouncing the sovereignty of his own country. All the more so, if he does it in Germany, independence from whom Poland so often had to fight in the past."

But members of what is broadly referred to as the "liberal-leftist" media generally support the government's efforts to stay on the German bandwagon. Jacek Pawlicki, of the newspaper Gazeta Wyborcza, said: "What is most important for Poland is that the new European deal be open for countries outside the eurozone … Merkel had promised that to Poland."

However, Sikorski also said in his speech that Poland did not support the idea of unifying tax policies across Europe, saying that should remain "in the purview of the state". So despite disagreeing on some of the German and French proposals for rescuing the eurozone from the current crisis, it is clear that Tusk's government is doing everything to make sure Poland is not left out of future EU decision-making processes. This seems a logical enough strategy, especially in view of the alternative.

As the PM told MPs last month: "You are either at the table or you are on the menu."

Banks took more than $50 billion from the European Central Bank on Wednesday in its first offering since slashing the cost of borrowing dollars, a sign that some euro zone banks have problems finding dollar funding as the region's debt crisis intensifies.

Top central banks last week acted to ensure banks outside the United States have easier access to dollars, which banks in Europe have more difficulty obtaining in the market as investor concerns about their exposure to the debt crisis have grown.

The ECB said banks asked for $50.7 billion in 84-day dollar funds and $1.602 billion in the 1-week tender in the operations, in which they are guaranteed to get all funds they requested.The demand was well above the $10 billion median forecast in a Reuters poll of money market traders.

Traders attributed banking strains in countries mired in the debt crisis as the main reason for the high amount allocated. "The demand had two reasons: The need for dollar funding, especially in Portugal, Spain etc. and the rest just for arbitrage purposes," a euro zone money market said.

With the cost of dollar funding slashed, the tender was also much more attractive to banks and the costs for 3-month funds were close to those available in the market. Three-month dollar Libor rates -- a measure of what banks in Europe are charging each other for dollar loans -- have risen to 0.53775 percent, levels not seen since mid-2010, when Europe's debt debacle flared up. Policymakers hope their action lowers those lending costs.

Central banks around the world last week announced steps to prevent a credit crunch among banks in Europe that are struggling with the region's debt crisis. The interest rate charged on the tenders was reduced, with the fixed rate charged at the 3-month tender of 0.59 percent and 0.58 percent in the 7-day tender, making them much more attractive to banks.

Analysts said that while the dollar operations were welcome, their impact in permanently easing strains should not be overestimated. "What really matters is what the ECB does tomorrow afternoon, and in that especially what they do with the long-term refinancing operations (LTROs) and on the collateral rules," Societe General economist Michala Marcussen said. "What would be extremely helpful right now is if we get longer maturity LTROs."

The ECB is expected to announce ultra-long 2-year or even 3-year refinancing operations after its meeting on Thursday.

Crisis MeasuresThe Fed set up dollar swaps with the ECB and the Swiss National Bank in December 2007. The facilities are unlimited. The total use of the lines peaked at more than $580 billion in December 2008. Demand for Fed dollar swaps was high right after their reintroduction in May 2010, with $9.2 billion scooped up on May 12, all through the ECB. However, since early June of last year demand has been muted.

In the two 3-month dollar operations conducted so far this year, in October and November, banks took $1.353 billion and $395 million, respectively. Those tenders, however, were conducted at a higher interest rate, which dampened demand. Demand in seven day tenders had fluctuated between zero and $575 million this year before today's operation. In addition to lowering the interest rate on the dollar tenders, the initial margin for the 3-month operation was cut to 12 percent from 20 percent previously.

Before the financial crisis, many foreign banks and investors had depended on money markets to borrow dollars to cheaply fund their dollar-denominated longer-term investments. After the collapse of Lehman Brothers, they found themselves scrambling for dollars to fund these obligations, driving up the dollar against local currencies and raising the specter of widespread defaults.

In the currency swaps, the U.S. Fed offers dollars to foreign central banks in exchange for their currencies. The foreign central banks then lend the dollars to banks in their domestic markets, enabling firms to access dollars at a time when normal financing channels have shut down.

Bank runs aren't a relic of the 20th century. In fact, they risk becoming a hallmark of the 21st—though with a twist.

The 2008 financial crisis displayed characteristics of a classic bank run, but people holding bank accounts weren't the ones scrambling to get their cash. It was lenders demanding their money from other financial institutions.

Indeed, today's panics are more likely to involve major financial institutions and are largely hidden from plain sight until they are severe enough to trigger plunging stock prices, bankruptcies, layoffs and rising unemployment. And the current European crisis is a reminder that some of the vulnerabilities exposed in 2008 still exist.

These panics often originate in the shadows of the banking system, where major financial institutions do business with one another. To say it isn't well understood would be an understatement; the Financial Stability Board, which works on behalf of G-20 countries for financial reform, has formed a task force to clarify what is meant by "shadow banking" in order to monitor and identify potential ways of regulating it.

The FSB's working definition of shadow banking is "credit intermediation involving entities and activities outside the regular banking system." It is akin to a banking system for banks and other financial institutions, where "depositors" exchange cash with borrowers in return for collateral for short periods of time, typically in the form of repurchase agreements. The FSB put the size of shadow-banking activities at roughly $60 trillion as of 2010—a sum that represents 25% to 30% of the total global financial system.

At best, shadow banking offers financial institutions a source of funding and liquidity on a day-to-day basis. At worst, it allows the buildup of leverage and systemic risk, as the 2008 financial crisis revealed.

Gary Gorton, a Yale University professor and leading researcher in this field, has documented that the crisis was effectively "a run by banks and firms on other banks."

While certain accounting practices have been tightened since 2008, "we've learned that runs in this part of the market can bring people down, and that vulnerability still exists," says Andrew Metrick, a colleague and frequent co-author of Mr. Gorton's.

There are two basic ways to make a financial system safer: insurance and regulation. Deposit insurance ended the debilitating bank runs that plagued the U.S. right up through the Great Depression. But the U.S. government isn't likely to extend such protections to financial institutions themselves, even if its bailouts amount to this in practice.

The other option is regulation. One option is to move more of the trading carried out in the shadow banking system onto centralized clearinghouses that authorities can more easily monitor and regulate. But it is difficult to prevent institutions from swapping assets directly with one another. And it isn't clear that moving this activity to clearinghouses would reduce systemic risk.

Worse, such a move could exacerbate the shortage of high-quality assets that are used as collateral in such transactions. The use of collateral is a key element in much of the short-term lending that occurs in the form of repurchase agreements, or "repo."

This generates enormous demand for risk-free, or nearly risk-free, assets because that is the most attractive collateral for such trades. Securitized mortgage loans were a huge part of the collateral base during the boom, not least because of their triple-A credit status at the time. European sovereign debt was similarly deemed safe.

In part because these two types of debt have lost their luster, there is a shortage of good collateral to lubricate the financial system. This could ultimately hamper the availability of credit at a time when central bankers world-wide are trying to spur it. So rather than trying to stamp out shadow banking, which could exacerbate this problem, regulators should look to gain control of it in other ways; one option is to regulate collateral like bank capital, Mr. Metrick says.

Another step is to tighten control over the riskiest participants in shadow banking, like money-market funds, which the Securities and Exchange Commission is pursuing. The urgency for changes here stems in part from the fact that, until recently, these funds had outsize exposure to European sovereign debt.

On top of that, disclosure of information like portfolio liquidity could prove more useful in the long term than another round of stress-testing banks. "If authorities are just looking at sovereign debt on the balance sheet, they've missed the point of 2008," says Dan Awrey, a lecturer at the University of Oxford's school of law whose work focuses on financial regulation.

Gradually, regulators may be starting to grasp this. Given the speed that Europe's debt crisis is unfolding, however, any measures that could help fend off future shadow-banking panics risk coming too late.

Spain's incoming prime minister, intent on curing the country's ailing banking sector, is considering cleanup plans that could dwarf the cost of previous efforts, including the creation of a state-funded "bad bank" to acquire toxic assets or a move to force banks to dramatically boost loan-loss reserves, people close to the situation say.

Prime Minister-elect Mariano Rajoy has said he wants to speed up the process of dealing with €176 billion ($236 billion) of impaired real-estate assets from Spain's housing bust, although he played down the potential cost of his plans ahead of last month's elections. The bad assets are choking off the flow of credit and making international investors wary of the euro zone's fourth-largest economy.

Bank cleanup is a key element of a program of economic reforms that Mr. Rajoy will present to French President Nicolas Sarkozy, German Chancellor Angela Merkel and U.S. Treasury Secretary Timothy Geithner on the sidelines of a meeting of the European People's Party, a gathering of leaders of center-right parties from around Europe, in Marseilles on Wednesday and Thursday.

European leaders are looking for clear commitments to reform from ailing countries like Spain and Italy ahead of a summit on Friday where they are expected to agree on new mechanisms of governance and financial support to underpin the euro.

"It makes sense to give restructuring a push by cleaning up balance sheets; it signals things are moving along," said Tano Santos, a finance professor at Columbia University in New York. "That has been one of the most damaging things in the Spanish crisis: the lack of movement."

A more aggressive response won't come cheap. Analysts estimate a quick fix, such as setting up the bad bank or forcing banks to dramatically boost loan-loss reserves and providing government capital to backstop them, could cost the Spanish state as much as €100 billion. That sum raises concerns that the effort could break the government's finances, as happened to the Irish government when it recapitalized its banks and blew out its deficit to 32% of gross domestic product in 2010.

But a growing chorus of economists and policy makers say the risks of failing to act decisively now are even greater; a new recession could further stress banks, and investor concerns about euro-zone debt problems threaten to scuttle the common currency.

Previous cleanup efforts of the outgoing government of Socialist Prime Minister José Luis Rodríguez Zapatero have fallen short, largely because they were designed to spread the cost over time and avoid a big one-time hit to the government's finances.

Mr. Rajoy isn't expected to publicly disclose his plans for dealing with the collapse of Spain's decadelong housing boom before taking his oath of office sometime around Dec. 19. But some people close the situation say the fastest way to deal with the problem would be to create a bad bank that purchases the impaired assets from lenders at discounted prices. This would force the institutions to recognize losses. It also would likely undermine their solvency ratios and require further funds to shore up their capital bases.

According to analysts at Morgan Stanley, Spain could acquire the entire €176 billion pile of impaired real-estate assets at the 58% discount applied by Ireland's bad bank, or a cost of €73.9 billion. This could be funded by swapping new government debt for the banks' soured real-estate assets.

However, the state would have to raise sufficient funds from investors to provide the banks with an estimated €28.5 billion in new capital to absorb losses that the banks would take in selling the assets at a steep discount. In all, the cost of the plan to the Spanish state could be €102.4 billion, or around 10% of Spanish GDP.

Still, if the €28.5 billion proves difficult to raise from private investors, given current market conditions, Mr. Rajoy has said he is open to the idea of requesting funds from the European Financial Stability Facility, the euro zone's bailout fund, to help finance the new capital needs. That is one of the facility's new mandates after it was revamped earlier this year.

Mr. Rajoy seemed to pour cold water on the bad-bank idea when, in the heat of his pre-election debate with Socialist rival Alfredo Perez Rubalcaba, he pledged not to give the banks a "single cent."

But one person close to the situation said Mr. Rajoy's team is studying the possibility of using Spain's deposit guarantee fund, which holds €6.59 billion and is financed by contributions from the banks, to pay for necessary capital injections. That wouldn't go against his campaign pledge because the bank-financed fund, not the government, would provide the cash. Requesting money from the EFSF, however, would because the EFSF is funded by Spain and other euro-zone countries.

Spain's outgoing government approved new regulations on Friday that will double banks' annual contributions to the deposit guarantee fund to around €1.5 billion. These are paltry sums compared to the banks' likely capital needs, but a system could be devised whereby the deposit guarantee fund repays over time any monies the government injects in the banks now, the person said.

On the sidelines of a conference last week, Spain's central bank chief said the country's banks need further "restructuring" and urged the government to consider approaches that had previously been ruled out because of their high cost, including the creation of a bad bank. "This mechanism should be studied…situations change," said Miguel Angel Fernández Ordóñez, noting that the EFSF was now on hand to provide financing.

A legal loophole in international brokerage regulations means that few, if any, clients ofMF Globalare likely to get their money back. Although details of the drama are still unfolding, it appears that MF Global and some of its Wall Street counterparts have been actively and aggressively circumventing U.S. securities rules at the expense (quite literally) of their clients.

MF Global's bankruptcy revelations concerning missing client money suggest that funds were not inadvertently misplaced or gobbled up in MF’s dying hours, but were instead appropriated as part of a mass Wall St manipulation of brokerage rules that allowed for the wholesale acquisition and sale of client funds through re-hypothecation. A loophole appears to have allowed MF Global, and many others, to use its own clients’ funds to finance an enormous $6.2 billion Eurozone repo bet.

If anyone thought that you couldn’t have your cake and eat it too in the world of finance, MF Global shows how you can have your cake, eat it, eat someone else’s cake and then let your clients pick up the bill. Hard cheese for many as their dough goes missing.

FINDING FUNDS

Current estimates for the shortfall in MF Global customer funds have now reached $1.2 billion as revelations break that the use of client money appears widespread. Up until now the assumption has been that the funds missing had been misappropriated by MF Global as it desperately sought to avoid bankruptcy.

Sadly, the truth is likely to be that MF Global took advantage of an asymmetry in brokerage borrowing rules that allow firms to legally use client money to buy assets in their own name - a legal loophole that may mean that MF Global clients never get their money back.

REPO RECAP

First a quick recap. By now the story of MF Global’s demise is strikingly familiar. MF plowed money into an off-balance-sheet maneuver known as a repo, or sale and repurchase agreement. A repo involves a firm borrowing money and putting up assets as collateral, assets it promises to repurchase later. Repos are a common way for firms to generate money but are not normally off-balance sheet and are instead treated as "financing" under accountancy rules.

MF Global used a version of an off-balance-sheet repo called a "repo-to-maturity." The repo-to-maturity involved borrowing billions of dollars backed by huge sums of sovereign debt, all of which was due to expire at the same time as the loan itself. With the collateral and the loans becoming due simultaneously, MF Global was entitled to treat the transaction as a "sale" under U.S. GAAP. This allowed the firm to move $16.5 billion off its balance sheet, most of it debt from Italy, Spain, Belgium, Portugal and Ireland.

Backed by the European Financial Stability Facility (EFSF), it was a clever bet (at least in theory) that certain Eurozone bonds would remain default free whilst yields would continue to grow. Ultimately, however, it proved to be MF Global’s downfall as margin calls and its high level of leverage sucked out capital from the firm. For more information on the repo used by MF Global please seeBusiness Law CurrentsMF Global – Slayed by the Grim Repo?

Puzzling many, though, were the huge sums involved. How was MF Global able to "lose" $1.2 billion of its clients’ money and acquire a sovereign debt position of $6.3 billion – a position more than five times the firm’s book value, or net worth? The answer it seems lies in its exploitation of a loophole between UK and U.S. brokerage rules on the use of clients funds known as "re-hypothecation".

RE-HYPOTHECATION

By way of background, hypothecation is when a borrower pledges collateral to secure a debt. The borrower retains ownership of the collateral but is "hypothetically" controlled by the creditor, who has a right to seize possession if the borrower defaults.

In the U.S., this legal right takes the form of a lien and in the UK generally in the form of a legal charge. A simple example of a hypothecation is a mortgage, in which a borrower legally owns the home, but the bank holds a right to take possession of the property if the borrower should default.

In investment banking, assets deposited with a broker will be hypothecated such that a broker may sell securities if an investor fails to keep up credit payments or if the securities drop in value and the investor fails to respond to a margin call (a request for more capital).

Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations much to the chagrin of hedge funds.

U.S. RULES

Under the U.S. Federal Reserve Board's Regulation T and SEC Rule 15c3-3, a prime broker may re-hypothecate assets to the value of 140% of the client's liability to the prime broker. For example, assume a customer has deposited $500 in securities and has a debt deficit of $200, resulting in net equity of $300. The broker-dealer can re-hypothecate up to $280 (140 per cent. x $200) of these assets.

But in the UK, there is absolutelyno statutory limiton the amount that can be re-hypothecated. In fact, brokers are free to re-hypothecate all and even more than the assets deposited by clients. Instead it is up to clients to negotiate a limit or prohibition on re-hypothecation. On the above example a UK broker could, and frequently would, re-hypothecate 100% of the pledged securities ($500).

This asymmetry of rules makes exploiting the more lax UK regime incredibly attractive to international brokerage firms such as MF Global or Lehman Brothers which can use European subsidiaries to create pools of funding for their U.S. operations, without the bother of complying with U.S. restrictions.

In fact, by 2007, re-hypothecation had grown so large that it accounted for half of the activity of the shadow banking system. Prior to Lehman Brothers collapse, theInternational Monetary Fund(IMF) calculated that U.S. banks were receiving $4 trillion worth of funding by re-hypothecation, much of which was sourced from the UK. With assets being re-hypothecated many times over (known as "churn"), the original collateral being used may have been as little as $1 trillion – a quarter of the financial footprint created through re-hypothecation.

BEWARE THE BRITS: CIRCUMVENTING U.S. RULES

Keen to get in on the action, U.S. prime brokers have been making judicious use of European subsidiaries. Because re-hypothecation is so profitable for prime brokers, many prime brokerage agreements provide for a U.S. client’s assets to be transferred to the prime broker’s UK subsidiary to circumvent U.S. rehypothecation rules.

Under subtle brokerage contractual provisions, U.S. investors can find that their assets vanish from the U.S. and appear instead in the UK, despite contact with an ostensibly American organisation.

Potentially as simple as having MF Global UK Limited, an English subsidiary, enter into a prime brokerage agreement with a customer, a U.S. based prime broker can immediately take advantage of the UK’s unrestricted re-hypothecation rules.

LEHMAN LESSONS

In fact this is exactly what Lehman Brothers did through Lehman Brothers International (Europe) (LBIE), an English subsidiary to which most U.S. hedge fund assets were transferred. Once transferred to the UK based company, assets were re-hypothecated many times over, meaning that when the debt carousel stopped, and Lehman Brothers collapsed, many U.S. funds found that their assets had simply vanished.

A prime broker need not even require that an investor (eg hedge fund) sign all agreements with a European subsidiary to take advantage of the loophole. In fact, in Lehman’s case many funds signed a prime brokerage agreement with Lehman Brothers Inc (a U.S. company) but margin-lending agreements and securities-lending agreements with LBIE in the UK (normally conducted under a Global Master Securities Lending Agreement).

These agreements permitted Lehman to transfer client assets between various affiliates without the fund’s express consent, despite the fact that the main agreement had been under U.S. law. As a result of these peripheral agreements, all or most of its clients’ assets found their way down to LBIE.

MF RE-HYPOTHECATION PROVISION

A similar re-hypothecation provision can be seen in MF Global’s U.S. client agreements. MF Global’s Customer Agreement for trading in cash commodities, commodity futures, security futures, options, and forward contracts, securities, foreign futures and options and currencies includes the following clause:

"7.Consent To Loan Or PledgeYou hereby grant us the right, in accordance with Applicable Law, to borrow, pledge, repledge,transfer, hypothecate, rehypothecate,loan, or invest any of the Collateral, including, without limitation, utilizing the Collateral to purchase or sell securities pursuant to repurchase agreements [repos] or reverse repurchase agreements with any party, in each case without notice to you, and we shall have no obligation to retain a like amount of similar Collateral in our possession and control."

In its quarterly report, MF Global disclosed that by June 2011 it had repledged (re-hypothecated) $70 million, including securities received under resale agreements. With these transactions taking place off-balance sheet it is difficult to pin down the exact entity which was used to re-hypothecate such large sums of money but regulatory filings and letters from MF Global’s administrators contain some clues.

According to a letter from KPMG to MF Global clients, when MF Global collapsed, its UK subsidiary MF Global UK Limited had over 10,000 accounts. MF Global disclosed in March 2011 that it had significant credit risk from its European subsidiary from "counterparties with whom we place both our own funds or securities andthose of our clients".

CAUSTIC COLLATERAL

Matters get even worse when we consider what has for the last 6 years counted as collateral under re-hypothecation rules.

Despite the fact that there may only be a quarter of the collateral in the world to back these transactions, successive U.S. governments have softened the requirements for what can back a re-hypothecation transaction.

Beginning with Clinton-era liberalisation, rules were eased that had until 2000 limited the use of re-hypothecated funds to U.S. Treasury, state and municipal obligations. These rules were slowly cut away (from 2000-2005) so that customer money could be used to enter into repurchase agreements (repos), buy foreign bonds, money market funds and other assorted securities.

Hence, when MF Global conceived of its Eurozone repo ruse, client funds were waiting to be plundered for investment in AA rated European sovereign debt, despite the fact that many of its hedge fund clients may have been betting against the performance of those very same bonds.

OFF BALANCE SHEET

As well as collateral risk, re-hypothecation creates significant counterparty risk and its off-balance sheet treatment contains many hidden nasties. Even without circumventing U.S. limits on re-hypothecation, the off-balance sheet treatment means that the amount of leverage (gearing) and systemic risk created in the system by re-hypothecation is staggering.

Re-hypothecation transactions are off-balance sheet and are therefore unrestricted by balance sheet controls. Whereas on balance sheet transactions necessitate only appearing as an asset/liability on one bank’s balance sheet and not another, off-balance sheet transactions can, and frequently do, appear on multiple banks’ financial statements. What this creates is chains of counterparty risk, where multiple re-hypothecation borrowers use the same collateral over and over again. Essentially, it is a chain of debt obligations that is only as strong as its weakest link.

With collateral being re-hypothecated to a factor of four (according to IMF estimates), the actual capital backing banks re-hypothecation transactions may be as little as 25%. This churning of collateral means that re-hypothecation transactions have been creating enormous amounts of liquidity, much of which has no real asset backing.

The lack of balance sheet recognition of re-hypothecation was noted in Jefferies’ recent 10Q (emphasis added):

"Note 7. Collateralized TransactionsWe pledge securities in connection with repurchase agreements, securities lending agreements and other secured arrangements, including clearing arrangements. The pledge of our securities is in connection with our mortgage?backed securities, corporate bond, government and agency securities and equities businesses. Counterparties generally have the right to sell or repledge the collateral.Pledged securities that can be sold or repledged by the counterparty are included within Financial instruments owned and noted as Securities pledged on our Consolidated Statements of Financial Condition.We receive securities as collateral in connection with resale agreements, securities borrowings and customer margin loans.In many instances, we are permitted by contract or custom to rehypothecate securities received as collateral. These securities maybe used to secure repurchase agreements, enter into security lending or derivative transactions or cover short positions.At August 31, 2011 and November 30, 2010, the approximate fair value of securities received as collateral by us that may be sold or repledged was approximately $25.9 billion and $22.3 billion, respectively. At August 31, 2011 and November 30, 2010, a substantial portion of the securities received by us had been sold or repledged.

We engage in securities for securities transactions in which we are the borrower of securities and provide other securities as collateral rather than cash.As no cash is provided under these types of transactions, we, as borrower, treat these as noncash transactions and do not recognize assets or liabilities on the Consolidated Statements of Financial Condition.The securities pledged as collateral under these transactions are included within the total amount of Financial instruments owned and noted as Securities pledged on our Consolidated Statements of Financial Condition.

According to Jefferies’ most recent Annual Report it had re-hypothecated $22.3 billion (in fair value) of assets in 2011 including government debt, asset backed securities, derivatives and corporate equity- that’s just $15 billion shy of Jefferies total on balance sheet assets of $37 billion.

HYPER-HYPOTHECATION

With weak collateral rules and a level of leverage that would make Archimedes tremble, firms have been piling into re-hypothecation activity with startling abandon. A review of filings reveals a staggering level of activity in what may be the world’s largest ever credit bubble.

Nor is lending confined to between banks. Intra-bank re-hypothecation is also possible as evidenced by filings from Wells Fargo. According to disclosures from Wachovia Preferred Funding Corp, its parent, Wells Fargo, acts as collateral custodian and has the right to re-hypothecate and use around $170 million of assets posted as collateral.

LIQUIDITY CRISIS

The volume and level of re-hypothecation suggests a frightening alternative hypothesis for the current liquidity crisis being experienced by banks and for why regulators around the world decided to step in to prop up the markets recently. To date, reports have been focused on how Eurozone default concerns were provoking fear in the markets and causing liquidity to dry up.

Most have been focused on how a Eurozone default would result in huge losses in Eurozone bonds being felt across the world’s banks. However, re-hypothecation suggests an even greater fear. Considering that re-hypothecation may have increased the financial footprint of Eurozone bonds by at least four fold then a Eurozone sovereign default could be apocalyptic.

U.S. banks direct holding of sovereign debt is hardly negligible. According to the Bank for International Settlements (BIS), U.S. banks hold $181 billion in the sovereign debt of Greece, Ireland, Italy, Portugal and Spain. If we factor in off-balance sheet transactions such as re-hypothecations and repos, then the picture becomes frightening.

As for MF Global’s clients, the recent adoption of an "MF Global rule" by the Commodity Futures Trading Commission to ban using client funds to purchase foreign sovereign debt, would seem to suggest that it was indeed client money behind its leveraged repo-to-maturity deal - a fact that will likely mean that very few MF Global clients few get their money back.

In an oddly prescient turn of events, yesterday we penned a post titled "Has The Imploding European Shadow Banking System Forced The Bundesbank To Prepare For Plan B?" in which we explained how it was not only the repo market, but the far broader and massively unregulated shadow banking system in Europe that was becoming thoroughly unhinged, and was manifesting itself in a complete "lock up in interbank liquidity" and which, we speculated, is pressuring the Bundesbank, which is well aware of what is going on behind the scenes, to slowly back away from what will soon be an "apocalyptic" event (not our words... read on).

Why was this prescient? Because today, Reuters' Christopher Elias has written the logical follow up analysis to our post, in which he explains in layman's terms not only how but why the lock up has occurred and will get far more acute, but also why the MF Global bankruptcy, much more than merely a one-off instance of "repo-to-maturity" of sovereign bonds gone horribly wrong is a symptom of two things: i) the lax London-based unregulated and unsupervised system which has allowed such unprecedented, leveraged monsters as AIG, Lehman and now as it turns out MF Global, to flourish until they end up imploding and threatening the world's entire financial system, and ii) an implicit construct embedded within the shadow banking model which permitted the heaping of leverage upon leverage upon leverage, probably more so than any structured finance product in the past (up to and including synthetic CDO cubeds), and certainly on par with the AIG cataclysm which saw $2.7 trillion of CDS notional sold with virtually zero margin.

Simply said: when one truly digs in, MF Global exposes the 2011 equivalent of the 2008 AIG: virtually unlimited leverage via the shadow banking system, in which there are practically no hard assets backing the infinite layers of debt created above, and which when finally unwound, will create a cataclysmic collapse of all financial institutions, where every bank is daisy-chained to each other courtesy of multiple layers of "hypothecation, and re-hypothecation."

In fact, it is a link so sinister it touches every corner of modern finance up to and including such supposedly "stable" institutions as Jefferies, which as it turns out has spent weeks defending itself, however against all the wrong things, and Canadian banks, which as it also turns out, defended themselvesagainst Zero Hedge allegations they may well be the next shoes to drop, as being strong and vibrant (and in fact just announced soaring profits and bonuses), yet which have all the same if not far greater risk factors as MF Global. Yet nobody has called them out on it. Until now.

But first, a detour to London...

As readers will recall, the actual office that blew up the world the first time around, was not even based in the US. It was a small office located on the top floor of 1 Curzon Street in London's Mayfair district, run by one Joe Cassano: the head of AIG Financial Products.

The reason why this office of US-based AIG was in London, is so that Cassano could sell CDS as far away from the eye of Federal regulators as possible. Which he did. In fact he sold an unprecedented $2.7 trillion worth of CDS just before the firm collapsed due to one small glitch in the system - the assumption that home prices could go down as well as up. Y

et the real question is why he sold so much CDS? The answer is simple - in a world of limited real assets, the only way to generate a practically limitless cash flow annuity would be to sell synthetic insurance on a virtually infinite amount of synthetic underlying. Which he did. Only when it came time to pay the claims, AIG blew up, forcing the government to bail it out, and set off the chain of events where we find ourselves now, where every day could be the developed world's last if not for the ongoing backstops, guarantees and bailouts of the central banking regime.

What is greatly ironic is that in the aftermath of the AIG collapse, the UK was shamed into admitting that it was its own loose, lax and unregulated system that allowed such unsupervised insanity to continue for as long as it did. As the Telegraph reminds us, "Conservative Party Treasury spokesman Philip Hammond called for a public inquiry into the FSA’s oversight of AIG Financial Products in Mayfair. "We must not allow London to become a bolthole for companies looking for a place to conduct questionable activities," he said.

"This sounds like a monumental cock-up by the FSA,"said Lib Dem shadow chancellor Vince Cable. "It is deeply ironic,"he added, that Brown was in Brussels last week calling for tougher global financial regulation just as the scandal over the FSA’s role in one of the key regulatory failures at the root of the global panic emerged as an international issue." It is ironic because the trail in the MF Global collapse, where it is yet another infinitely leveragable product that once again comes to the fore, once again goes straight to that hub for "questionable activities" - London.

But before we explain why London is once again to blame for what was not only the immediate reason of the MF Global collapse, but could well precipitate the next global collapse, a quick look at rehypothecation.

As Reuters points out, it was not so much the act of creating "repos-to-maturity" that imperiled MF Global, but what is a secret gold mine for those privy to it - the process of re-hypothecation of collateral.

[h]ypothecation is when a borrower pledges collateral to secure a debt. The borrower retains ownership of the collateral but is "hypothetically"controlled by the creditor, who has a right to seize possession if the borrower defaults.

In the U.S., this legal right takes the form of a lien and in the UK generally in the form of a legal charge. A simple example of a hypothecation is a mortgage, in which a borrower legally owns the home, but the bank holds a right to take possession of the property if the borrower should default.

In investment banking, assets deposited with a broker will be hypothecated such that a broker may sell securities if an investor fails to keep up credit payments or if the securities drop in value and the investor fails to respond to a margin call (a request for more capital).

Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations much to the chagrin of hedge funds.

So far so good, assuming there was regulation, and assuming if regulation failed, that the firms that blew up as a result of their greed would truly blow up, instead of being resurrected as TBTF zombies by a government in dire need of rent collection and lobby cash (because with or without regulation, if those who fail are not allowed to fail, then the whole point of capitalism is moot). But... there is always a snag.

Under the U.S. Federal Reserve Board's Regulation T and SEC Rule 15c3-3, a prime broker may re-hypothecate assets to the value of 140% of the client's liability to the prime broker. For example, assume a customer has deposited $500 in securities and has a debt deficit of $200, resulting in net equity of $300. The broker-dealer can re-hypothecate up to $280 (140 per cent. x $200) of these assets.

But in the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated. In fact, brokers are free to re-hypothecate all and even more than the assets deposited by clients. Instead it is up to clients to negotiate a limit or prohibition on re-hypothecation. On the above example a UK broker could, and frequently would, re-hypothecate 100% of the pledged securities ($500).

This asymmetry of rules makes exploiting the more lax UK regime incredibly attractive to international brokerage firms such as MF Global or Lehman Brothers which can use European subsidiaries to create pools of funding for their U.S. operations, without the bother of complying with U.S. restrictions.

In fact, by 2007, re-hypothecation had grown so large that it accounted for half of the activity of the shadow banking system. Prior to Lehman Brothers collapse, the International Monetary Fund (IMF) calculated that U.S. banks were receiving $4 trillion worth of funding by re-hypothecation, much of which was sourced from the UK. With assets being re-hypothecated many times over (known as "churn"), the original collateral being used may have been as little as $1 trillion – a quarter of the financial footprint created through re-hypothecation.

So let's see: a Prime Broker taking posted collateral, then using the same collateral as an instrument for hypothecation with a net haircut, then repeating the process again, and again... Ring a bell? If you said "fractional reserve lending" - ding ding ding. In essence what re-hypothecation, and subsequent levels thereof, especially once in the shadow banking realm, allows Prime Brokers is to become de facto banks only completely unregulated and using synthetic assets as collateral. Curiously enough it was earlier today that we also penned "ECB Confirms Shadow Banking System In Europe In Tatters" in which we explained that since ECB has to expand the eligible collateral it will accept, there is no real collateral left, meaning the re-hypothecation process in Europe has experienced terminal failure. Yet the kicker is that the "safety haircut" only occurs in the US. Not in the UK. And therein lies the rub. In the UK, the epic failure of supervision has allowed banks to become de facto monsters of infinite shadow banking fractional reserve leverage - every bank's wet dream! Naturally, Prime Brokers have known all about this which explains the quiet desire to conduct re-hypothecation out of London-based offices for every US-based (and Canadian) bank. Reuters explains:

Keen to get in on the action, U.S. prime brokers have been making judicious use of European subsidiaries. Because re-hypothecation is so profitable for prime brokers, many prime brokerage agreements provide for a U.S. client’s assets to be transferred to the prime broker’s UK subsidiary to circumvent U.S. rehypothecation rules.

Under subtle brokerage contractual provisions, U.S. investors can find that their assets vanish from the U.S. and appear instead in the UK, despite contact with an ostensibly American organisation.

Potentially as simple as having MF Global UK Limited, an English subsidiary, enter into a prime brokerage agreement with a customer, a U.S. based prime broker can immediately take advantage of the UK’s unrestricted re-hypothecation rules.

While we already mentioned AIG as an example of the lax UK-based regulatory regime, it is another failed bank that is perhaps the best example of levered failure but in the specific re-hypothecation context: Lehman Brothers itself.

This is exactly what Lehman Brothers did through Lehman Brothers International (Europe) (LBIE), an English subsidiary to which most U.S. hedge fund assets were transferred. Once transferred to the UK based company, assets were re-hypothecated many times over, meaning that when the debt carousel stopped, and Lehman Brothers collapsed, many U.S. funds found that their assets had simply vanished.

A prime broker need not even require that an investor (eg hedge fund) sign all agreements with a European subsidiary to take advantage of the loophole. In fact, in Lehman’s case many funds signed a prime brokerage agreement with Lehman Brothers Inc (a U.S. company) but margin-lending agreements and securities-lending agreements with LBIE in the UK (normally conducted under a Global Master Securities Lending Agreement).

These agreements permitted Lehman to transfer client assets between various affiliates without the fund’s express consent, despite the fact that the main agreement had been under U.S. law. As a result of these peripheral agreements, all or most of its clients’ assets found their way down to LBIE.

And now we get back to the topic at hand: MF Global, why and how it did precisely what Lehman did back then, why it did this in London, and why its failure is a symptom of something far more terrifying than merely investing money in collapsing PIIGS bonds.

"7. Consent To Loan Or Pledge You hereby grant us the right, in accordance with Applicable Law, to borrow, pledge, repledge, transfer, hypothecate, rehypothecate, loan, or invest any of the Collateral, including, without limitation, utilizing the Collateral to purchase or sell securities pursuant to repurchase agreements [repos] or reverse repurchase agreements with any party, in each case without notice to you, and we shall have no obligation to retain a like amount of similar Collateral in our possession and control."

In its quarterly report, MF Global disclosed that by June 2011 it had repledged (re-hypothecated) $70 million, including securities received under resale agreements. With these transactions taking place off-balance sheet it is difficult to pin down the exact entity which was used to re-hypothecate such large sums of money but regulatory filings and letters from MF Global’s administrators contain some clues.

According to a letter from KPMG to MF Global clients, when MF Global collapsed, its UK subsidiary MF Global UK Limited had over 10,000 accounts. MF Global disclosed in March 2011 that it had significant credit risk from its European subsidiary from "counterparties with whom we place both our own funds or securities and those of our clients".

It gets even worse when one considers that over the years the actual quality of good collateral declined, meaning worse and worse collateral was to be pledged in these potentially infinite recursive loops of shadow banking fractional reserve lending:

Despite the fact that there may only be a quarter of the collateral in the world to back these transactions, successive U.S. governments have softened the requirements for what can back a re-hypothecation transaction.

Beginning with Clinton-era liberalisation, rules were eased that had until 2000 limited the use of re-hypothecated funds to U.S. Treasury, state and municipal obligations. These rules were slowly cut away (from 2000-2005) so that customer money could be used to enter into repurchase agreements (repos), buy foreign bonds, money market funds and other assorted securities.

Hence, when MF Global conceived of its Eurozone repo ruse, client funds were waiting to be plundered for investment in AA rated European sovereign debt, despite the fact that many of its hedge fund clients may have been betting against the performance of those very same bonds.

At this point flashing red lights should be going though the head of anyone who lived through the AIG cataclysm: in effect the rehypothecation scenario affords the same amount of leverage, and potentially even less supervision that the CDS market. Said otherwise, the counteparty risk of daisy chaining defaults is on par with that in the case of AIG.

As well as collateral risk, re-hypothecation creates significant counterparty risk and its off-balance sheet treatment contains many hidden nasties. Even without circumventing U.S. limits on re-hypothecation, the off-balance sheet treatment means that the amount of leverage (gearing) and systemic risk created in the system by re-hypothecation is staggering.

Re-hypothecation transactions are off-balance sheet and are therefore unrestricted by balance sheet controls. Whereas on balance sheet transactions necessitate only appearing as an asset/liability on one bank’s balance sheet and not another, off-balance sheet transactions can, and frequently do, appear on multiple banks’ financial statements. What this creates is chains of counterparty risk, where multiple re-hypothecation borrowers use the same collateral over and over again. Essentially, it is a chain of debt obligations that is only as strong as its weakest link.

And the kicker:

With collateral being re-hypothecated to a factor of four (according to IMF estimates), the actual capital backing banks re-hypothecation transactions may be as little as 25%. This churning of collateral means that re-hypothecation transactions have been creating enormous amounts of liquidity, much of which has no real asset backing.

It turns out the next AIG was among us all along, only because it was hidden deep in the bowels of the unmentionable shadow banking system, out of sight (by definition) meant out of mind. Only it was not: and at last check there was $15 trillion in the shadow banking system in the US alone, where the daisy chaining of counteparty risk meant that any liquidity risk flare up would mean the AIG bankruptcy was not even a dress rehearsal for the grand finale.

But where does one look for the next AIG? Who would be stupid enough to disclose the fact that they have essentially the same risk on their off-balance sheet books as AIG had on its normal books? Once again, we turn to Reuters:

The lack of balance sheet recognition of re-hypothecation was noted in Jefferies’ recent 10Q (emphasis added):

"Note 7. Collateralized Transactions We pledge securities in connection with repurchase agreements, securities lending agreements and other secured arrangements, including clearing arrangements. The pledge of our securities is in connection with our mortgage?backed securities, corporate bond, government and agency securities and equities businesses. Counterparties generally have the right to sell or repledge the collateral.Pledged securities that can be sold or repledged by the counterparty are included within Financial instruments owned and noted as Securities pledged on our Consolidated Statements of Financial Condition. We receive securities as collateral in connection with resale agreements, securities borrowings and customer margin loans. In many instances, we are permitted by contract or custom to rehypothecate securities received as collateral. These securities maybe used to secure repurchase agreements, enter into security lending or derivative transactions or cover short positions. At August 31, 2011 and November 30, 2010, the approximate fair value of securities received as collateral by us that may be sold or repledged was approximately $25.9 billion and $22.3 billion, respectively. At August 31, 2011 and November 30, 2010, a substantial portion of the securities received by us had been sold or repledged. We engage in securities for securities transactions in which we are the borrower of securities and provide other securities as collateral rather than cash. As no cash is provided under these types of transactions, we, as borrower, treat these as noncash transactions and do not recognize assets or liabilities on the Consolidated Statements of Financial Condition. The securities pledged as collateral under these transactions are included within the total amount of Financial instruments owned and noted as Securities pledged on our Consolidated Statements of Financial Condition.

According to Jefferies’ most recent Annual Report it had re-hypothecated $22.3 billion (in fair value) of assets in 2011 including government debt, asset backed securities, derivatives and corporate equity- that’s just $15 billion shy of Jefferies total on balance sheet assets of $37 billion.

Oh Jefferies, Jefferies, Jefferies. Barely did you manage to escape the gauntlet of accusation of untenable gross (if not net) sovereign exposure, that you will soon, potentially as early as tomorrow, have to defend your zany rehypothecation practices. One wonders: will Sean Egan downgrade you for this latest transgression as well? All the better for Leucadia though: one more million shares that Dick Handler can sell to Ian Cumming.

Yet Jefferies is just the beginning. It gets much, much worse.

With weak collateral rules and a level of leverage that would make Archimedes tremble, firms have been piling into re-hypothecation activity with startling abandon. A review of filings reveals a staggering level of activity in what may be the world’s largest ever credit bubble.

And people were wondering why looking through the balance sheet of Canadian banks revealed no alert signals. It is because all the exposure was off the books! Hundreds of billions of dollars worth. As for JPM and MS amounting to nearly a trillion in rehypothecation... well, we are confident the market will be delighted to start pricing that particular fat-tail risk as soon as tomorrow.

Yet it is Reuters' conclusion that strikes home, and is identical to what we said last night about the liquidity lock up in Europe and what it means for the shadow banking system, although from the perspective of an inverted cause and effect:

The volume and level of re-hypothecation suggests a frightening alternative hypothesis for the current liquidity crisis being experienced by banks and for why regulators around the world decided to step in to prop up the markets recently.

That's precisely right: the shadow banking system, so aptly named because its death rattle can never be seen out in the open, is slowly dying. As noted yesterday. But lest we be accused of hyperventilating, this time we will leave a respected, non-fringe media to bring out the big adjective guns:

To date, reports have been focused on how Eurozone default concerns were provoking fear in the markets and causing liquidity to dry up....Most have been focused on how a Eurozone default would result in huge losses in Eurozone bonds being felt across the world’s banks. However, re-hypothecation suggests an even greater fear. Considering that re-hypothecation may have increased the financial footprint of Eurozone bonds by at least four fold then a Eurozone sovereign default could be apocalyptic.

U.S. banks direct holding of sovereign debt is hardly negligible. According to the Bank for International Settlements (BIS), U.S. banks hold $181 billion in the sovereign debt of Greece, Ireland, Italy, Portugal and Spain. If we factor in off-balance sheet transactions such as re-hypothecations and repos, then the picture becomes frightening.

And there you have it: in this world where distraction and diversion often times is the only name of the game, while banks were pretending to have issues with their traditional liabilities, it was really the shadow liabilities where the true terrors were accumulating. Because in what has become a veritable daisy chain of linked shadow exposure, we are now back where we started with the AIG collapse, only this time the regime is decentralized, without the need for a focal, AIG-type center. What this means is that the collapse of the weakest link in the daisy-chain sets off a house of cards that eventually will crash even the biggest entity due to exponentially soaring counterparty risk: an escalation best comparable to an avalanche - where one simple snowflake can result in a deadly tsunami of snow that wipes out everything in its path. Only this time it is not something as innocuous as snow: it is the compounded effect of trillions and trillions of insolvent banks all collapsing at the same time, and wiping out the developed world and the associated 150 years of the welfare state as we know it.

In this light, it makes far more sense why, as we suggested yesterday, the sanest central bank in Europe, the German Bundesbank, is quietly making stealthy preparations to get the hell out of Dodge, as it realizes all too well, that the snowflake has arrived: MF Global's bankruptcy has already set off a chain of events which not even all the world's central banks can halt. Which is ironic for the Buba - what it is doing is "too little too late." But at least it is taking proactive steps. For all the other central banks in the Eurozone, and soon the world, unfortunately the deer in headlights image is the only applicable one. And all because of unbridled greed, bribed and corrupt regulators sleeping at their job, and governments which encourage the TBTF modus operandi as the only fall back one, which in turn gave banks a carte blanche to take essentially unlimited risk.

While we are waiting for Mario and Merkozy plus, just a quick thought on one of the EMU break-up reports hitting my desk daily, and sometimes in twos and threes. (Ah, how I look back to those halcyon days when it was just we happy few, we band of brothers, a tiny handful of Little Englanders, Danes, Swedes, cheese-eating Souverainistes, and Czech patriots, against the crushing force of orthodoxy.)

The Dutch bank ING has had another go at the numbers, calculating that the Greek Drachma would fall by 80pc against the D-Mark in a full-blown disintegration. The Escudo and the Peseta would fall by 50pc, and the Lira and the Punt by 25pc. Germany would suffer a "deflationary shock".

The whole eurozone would crash into depression, with a GDP contraction of around 9pc in 2012 — Germany (-7.4), France (-9.1), Portugal (-12.7), Greece (-13.1). Outside: UK (-5), Poland (-6.6), US (-0.2), Japan (-1.1). The price of oil would drop to $55 a barrel. The US would flirt with deflation. The contraction would continue into 2013, before gradually stabilizing.

"Events of the past year have proved beyond doubt that the Eurozone is far from a textbook `optimal currency area'. But this is an omelette that cannot readily be unscrambled ," said ING's Mark Cliffe. Oddly enough, I lunched with Mr Cliffe days before the ERM blew up in September 1992, so this all has a funny feel to me.

His report is less dire than a UBS note predicting a 50pc collapse in peripheral GDP, and 20pc to 25pc in the core, but it still begs the question: If the intra-EMU currency misalignment is so extreme that free floats would cut Greece by 80pc, and Spain by 50pc, it surely validates the eurosceptic argument that monetary union has become a preposterous and unworkable arrangement.

It will take hideous contortions to hold the system together for year after year if ING is close to right on these numbers, with perma-slump, endless austerity, and ever greater macro-economic absurdities, so why persist?

Actually, I don't agree that Spain is such a basket case. Its exports have bounced back briskly – almost at a German pace – since the Great Recession. Spain reminds me of the UK in 1992 when the mantra was that Britain had run into trouble because it joined the ERM at an over-valued rate of D-Mark 2.95.

A decade later the pound was slightly stronger at 3.20 (synthetic D-Mark). In reality, sterling was in crisis in 1992 because the UK cycle (recession) was not aligned with the German cycle (overheating). The issue was the wrong interest rate, not the wrong exchange rate.

Spain has some of the same problems today, though excess house construction has been far more extreme than the UK in 1992, and the economy is about 15pc over-valued on unit labour costs. Bad, but not hopeless. In my view, Spain would have some chance of making it in EMU despite past mistakes if the overall policy in Euroland were less contractionary. Unfortunately, the country's best efforts over the last year have been blown to pieces by 1930s policy-makers and Neo-Calvinists.

Be that as it may, ING's Mr Cliffe does not agree with those who think the D-Mark will soar against the dollar after a break-up, mimicking the Swiss franc. It will be sucked down by depression and mayhem. Nor would the euro rally after spinning Greece back into the Aegean. The residual core currency would plunge below dollar parity, and perhaps below $0.85.

"The notion of irreversibility of EMU would be shattered forever," he said. "Our base case remains that EMU will survive, courtesy of a ‘grand bargain’ that exchanges tighter fiscal discipline and economic reform for German support for ECB action to aid the funding of peripheral governments and banks and a commitment to launch a common Eurozone government bond." Well, maybe, but they had better get on with it.

The report does not address the proposal of ex-BDI chief Hans-Olaf Henkel: that Germany and the Kaisertreu should leave EMU to the Latins, orchestrating an orderly North-South divorce. Many readers point out that this would be impossible to carry out. The moment anybody got whiff of such planning, there would be an instant run on the banks and sovereign debt of the southern bloc.

So yes, those readers are right. Even German withdrawal would be absolutely bloody. There is no clean way out of this. The question is which do you prefer: a horrible end, or endless horror?

Germany, admired and envied for its economic success, has become a model for Europe in the debt crisis. The Continent is becoming more German as countries get serious about fiscal discipline. But the nation's new dominance is also stirring resentment, and old anti-German sentiments are returning. By SPIEGEL Staff

A French tricolor flag fluttering on a video screen provides the grand backdrop for Nicolas Sarkozy, who is about to take to the stage to talk about the euro crisis. The flag is huge, almost as if the organizers were attempting to allay any doubts that the speaker really is the French president rather than a mere emissary of German Chancellor Angela Merkel.

When Sarkozy appeared in front of his supporters in Toulon last Thursday, he spoke of the "fear that France could lose control of its own destiny." His dramatic words were an appeal to French national pride, but his response to those fears was anything other than nationalist: "France and Germany have decided to unite their fate," he announced. So-called "convergence" -- greater alignment of the two countries -- was the only way out of the crisis.

There is no doubt which country wants to align itself with which. Later that day, one of his advisers said Sarkozy wanted "supply oriented economic policies and debt reduction modeled on those of Gerhard Schröder," Merkel's predecessor. In his speech, the president even announced a "jobs summit" between employers and unions just like the one initiated by then-Chancellor Schröder six years ago.

The very next day the French daily newspaper Libération ran an article under the headline "A President Modeled on the Germans," which claimed "If you closed your eyes, you could hear Merkel speaking" during Sarkozy's speech.

During a televised interview back in early November, Sarkozy uttered almost unimaginable words for a French president: "All my efforts are directed towards adapting France to a system that works. The German system."

Speaking in Toulon, Sarkozy condemned the long-established French policy of buying economic growth by simply borrowing more. He said France could only overcome the current crisis through "work, effort and controlled spending," objectives that sounded eerily German. Fortunately the tricolor was still fluttering, and the event closed with a rendition of the Marseillaise.

In these days of crisis in Europe, the "German model" has become something of a magic formula. Like it or not, the dusty, dry Germans now seem to hold the key to European salvation.

From 'Sick Man of Europe' to ParagonHow has it come to this? For a long time, Germany wasn't regarded as a model state. The nation has been plagued by guilt since World War II and by economic stagnation since the late 1980s.

The Germans saw themselves surrounded by neighbors who seemed to be doing things better: The Scandinavians had their welfare state, the French their family friendly policies, the Brits had their service industry, and countries to the east had lower taxes. As recently as 2002, Newsweek dubbed Germany "the sick man of Europe," calling it a country hit by economic strife and unsure about its place in the world.

And yet suddenly, Germany is being held up as a shining example for everyone else. It is almost the only country in the euro zone that the markets still trust. It is almost the only one that has a history of carrying out far-reaching structural reforms. Almost overnight, Germany has become the de facto center of Europe.

After the war, the French and the British sought to bind Germany into a united Europe to prevent it from ever becoming the dominant force in Europe again. But now its economic strength has made it the region's natural leader for the first time since 1945, although neither the Germans nor the continent's other citizens seem comfortable with this state of affairs yet.

As a result, Germany's dominance in Europe has brought forth a paradox. As admiration for its economic successes has grown, so too has increasing criticism of the way it is handling its role as the leading force. Not only does it appear to have done everything right on its own. It is also the country that -- still -- refuses to consider saving the 17-member eurozone by printing money or issuing euro bonds. It is also forcing others to adopt its cost-cutting recipes.

In this, it is becoming clear that Angela Merkel isn't the only person who wants to reshape Europe in Germany's image. The chancellor has become less inhibited about expressing her determination to revamp Europe -- but many countries have already decided for themselves that Europe must follow Germany's example if the common currency is to be saved.

Europe Becoming More GermanEurope's Germanization can be seen all over the continent. In Italy, for example, the popular playboy Silvio Berlusconi has been replaced by a government of bland technocrats who appear to have consciously distanced themselves from any hint of being laissez-faire or Mediterranean.

The new prime minister, Mario Monti, has been talking about introducing tough austerity measures ever since he took office a month ago. Monti himself is so down-to-earth and conservative that his fellow countrymen call him "more German than the Germans." Even the Italian media -- for instance the Sunday evening TV program "Report" -- has taken to listing everything the Germans do better: Their waste-recycling systems, their competitiveness and their education system.

In Spain, the outgoing Socialist Premier José Luis Rodriguez Zapatero has cut public-sector salaries and welfare payments. But just like German labor-market reformer Gerhard Schröder before him, Zapatero has been voted out of office. His successor, Mariano Rajoy, has already pledged to bring the country's national debt down to 4.4 percent of GDP in 2012, exactly as Merkel has demanded.

Greece, which is demanding drastic belt-tightening from its citizens, is the most reluctant to Germanize, not least because this would be more painful than in any other euro-zone country. Since November, a 30-man European Union team known as the Task Force and headed by a German, Horst Reichenbach, has been teaching Greek civil servants how to survey land, run real estate registers and levy property tax. That hasn't exactly reduced the animosity the local population feels towards Germans.

Nevertheless, politicians and the media in virtually every European country have for months been discussing German idiosyncrasies like its dual (theory- and practice-based) vocational training system and the social partnership between employers and unions, both of which have helped the country attain its current leadership. Everyone is keen to copy the best elements of the German system.

French AngstNowhere is Germany as threatening to the national psyche as in France. For weeks now, the main focus of public debate has been why the Germans are doing so well and the French so badly. Day after day, the newspapers almost obsessively compare the two countries. "The German Europe" was the headline of a recent article in business magazine Challenges; an expression of wonder and dread alike.

When French auto manufacturing group PSA, whose brands include Peugeot and Citroen, announced plans to cut 6,000 jobs a month ago, viewers of the evening news in France were treated to a graphic that dealt another blow to their national pride: This showed that PSA's production numbers have stagnated over the last 10 years while those of German competitor Volkswagen have risen sharply.

Economist Jean Peyrelevade recently published a book, "France: A State in Crisis," on this very issue. The book is essentially an instruction manual detailing how France could become more like Germany. Peyrelevade's conclusion is devastating: German companies are financially strong, French ones deeply indebted.

Germany has been more rigorous in raising the retirement age than neighboring France, whose citizens have a mandated 35-hour work week. German salaries and wages have risen at a lower rate than productivity, while the opposite is true in France. "We in France have increased our national debt time and time again because the Germans enabled us to get such cheap loans," Peyrelevade says. "Germany has therefore bankrolled our demise."

France's national debt now stands at 85 percent of gross domestic product, and the country is poised to lose its top AAA credit rating. This is another reason why Sarkozy is at pains to chain his country to Germany, its historic rival. In the past, France was always proud of its combination of Mediterranean lifestyle and north European economic performance. Now Sarkozy warns of the danger of "being dragged down by countries in the south."

A year-and-a-half ago, Christine Lagarde, who was French finance minister at the time, criticized German wage-dumping practices. Today Ms. Lagarde heads the International Monetary Fund, and nobody wants to hear such talk. It has become fashionable to admire the German model. Centrist presidential candidate François Bayrou has written a book in which he demands Schröderesque reforms, and even Socialist Party candidate François Hollande praises attempts to cut non-wage costs.

But are the French and other Europeans really prepared to implement tough social reforms, extend their working week and make other changes to their pension system? Do they really know what it means for every single person if their state is forbidden from spending more than it collects?

Admired and VilifiedThroughout Europe, wherever austerity measures have been either announced or already implemented, Germany has been or is being blamed for it. After all, it is the Germans who are demanding these reforms. Very quickly, praise is being replaced by criticism that Chancellor Merkel is meddling in the domestic policies of other countries.

This is the flipside of Germany's dominance in Europe. The right-wing Spanish daily newspaper ABC recently wrote about the alleged "Germanization of Europe," and a journalist commented that Germany was in the process of "winning World War III: the money war." Many in Spain were appalled by the wording of a telegram the German chancellor sent to Mariano Rajoy to congratulate him on his election victory.

"Dear Mr. Rajoy," she had written in the message, which the left-leaning newspaper Pùblico quoted from both the German and in translation. Now that he had been given a clear mandate, Merkel said, Rajoy should "rapidly" take the necessary steps. If, as seems likely, the text was leaked by someone close to the prime minister-designate, it was a shrewd move indeed, for the Spanish now have someone to blame for their suffering.

And so the specter of the ugly German has raised its head once more. In Greece, swastikas made out of the stars of the European Union flag have long been a popular motif at demonstrations, not to mention pictures of the German chancellor in a kind of SS uniform.

'Fourth Reich'Georgios Trangas, one of Greece's best-known journalists, said his country had become "a German protectorate of the Fourth Reich in southern Europe." Anti-German sentiments are a key ingredient of his nightly talk show. He currently wishes his viewers a "Merry German Christmas" as marching music plays in the background.

Meanwhile, Italian television is depicting Chancellor Merkel wearing a Kaiser-era spiked helmet, and even prominent politicians such as Frenchman Arnaud Montebourg, the rising star of the left wing of the French Socialist Party, no longer have any qualms about ridiculing the "German model" with all the demagogical tools at their disposal: "The issue of German nationalism is returning through the Bismarckian policies championed by Mrs. Merkel," Montebourg said last week.

He said France must stand up to Germany and defend its values against what he called "German dictates." Montebourg was heavily criticized for his words, even from within his own party. But the closer Sarkozy aligns himself with Merkel, the louder people in France can be expected to voice criticism of Germany.

The government in Berlin has been helpless in the face of such animosity from abroad. "It really is dramatic that all the positive capital we amassed over the decades is being destroyed in a matter of months," a high-ranking government official said. There wasn't much Germany could do about it, he added. Germany's ambassadors throughout the EU have been instructed to spell out the German position more clearly and to nurture contacts with the foreign media.

The German government knows such PR work can only have a limited impact. Officials in the Chancellery, Merkel's office, say the most important thing right now is to stand side by side with France to avoid creating the impression that Germany is dominating Europe.

Merkel the TeacherHolding the reins of economic and political power in Europe is a new experience for Germany, but Merkel isn't just being criticized because she is calling the shots in Europe. She is also being accused of taking a one-sided view of Germany's leadership role -- of interpreting it simply as a kind of educational project.

She doesn't seem to have any other solutions up her sleeve, nor does she instill trust or promise salvation. She demands a great deal without saying where the path will lead. Many countries therefore find themselves wishing for more guidance from Germany rather than less.

Ironically enough, these also include Poland, the country which for a long time most feared a resurgent Germany. Last week, Polish Foreign Minister Radoslaw Sikorski gave a remarkable speech in Berlin in which he described the collapse of the euro zone as "the greatest threat for Poland's security and well-being."

Just five years ago, Sikorski said the German-Russian agreement over a Baltic Sea pipeline reminded him of Hitler's pact with Stalin in 1939. Now he says, "I'm less worried about Germany's power than about its failure to act. It has become Europe's essential nation. It must not fail in its leadership. Rather than dominate, it must lead the reform process."

Few countries have gained more from EU membership than Poland. Its economy boomed even during the global financial crisis of 2009. "Poland wants to become the France of the east," says Waldemar Czachur of the Center for International Relations.

Poland's moderate Prime Minister Donald Tusk is almost falling over himself to be a model student. Thanks to this, Poland is already doing what many others must also eventually accomplish: It is eagerly cutting costs, it has written a debt ceiling into its constitution and is now even raising its retirement age. And in spite of the crisis, Warsaw still plans to adopt the euro in four years' time.

If Nicolas Sarkozy isn't careful, Tusk will soon replace him as Angela Merkel's new favorite.

From the Occupy Wall Street and Tea Party movements of the US to the rise of populist politics in Europe, the globalisation backlash is everywhere.

A number of years ago, a story went around that sprouts were being transported from across Britain to an East Anglian airport, from where they were sent to Poland for washing and packaging before being air-freighted back again for sale in supermarkets located but a few miles from where they were grown.

This is an extreme example of the sometimes insane supply-chain dynamics of modern-day globalisation, but it speaks loudly to widespread disillusionment with the once-unquestioned blessings of free trade. From the Occupy Wall Street and Tea Party movements of the US to the renewed rise of populist politics in Europe, the backlash is everywhere to be seen.

In real terms, Americans are on average no better off than they were 30 years ago; in Britain, the Institute for Fiscal Studies says that our real disposable incomes are in the midst of a 14-year freeze. Vast tracts of gainful employment in textiles, potteries, shoe-making, machine tools and many other industries have disappeared, to be replaced by… well, not very much at all outside the now languishing financial services industry and the housing market.

The West’s competitive advantage, even in hi-tech industries such as pharmaceuticals and aerospace, is being fast whittled away too. The welfare and health entitlements to which we have become accustomed look ever more unaffordable, while the final-salary pensions that workers could once expect as reward for a lifetime of service are now confined to the public sector – and those too will surely be gone within 10 years. It is small wonder that the benefits of free trade are now so widely questioned.

Critics of globalisation, such as Joseph Stiglitz, the Nobel laureate in economics, used to focus on the supposed harm that Western-inspired trade liberalisation was inflicting on the developing world. Few would these days think this the correct way of looking at the problem.

On the contrary, by opening up the global economy to Asia, Latin America and Eastern Europe, the West seems to have unleashed a doomsday machine which threatens ever-greater destruction of its own living standards. After a brief number of years in which globalisation made everything seemingly cheaper, the terms of trade have moved badly against the West.

Sure enough, the world as a whole is getting a whole lot richer. In the past decade alone, the global economy has doubled in size. But most of the benefits of this explosion in activity have gone to the developing world and, in the West, the already rich, highly educated and talented. The wealth divide has widened to record levels almost everywhere.

Western business leaders embraced globalisation not just because it opens up new markets, introduces new ideas and weeds out unproductive, protected sectors, but because it allows for lower production costs and so bigger profits. It doesn’t seem to have occurred to them that if you don’t provide Western consumers with jobs, they’ll be priced out of the market and the mother economy will wither and die.

The principles of free trade are the same for nations as they are for individuals. Rather than trying to produce everything we need to live, most of us choose to work in quite specialist forms of employment, the product of which we sell to others. We then use the proceeds to buy in other goods and services. Nations ought similarly to derive a collective economic benefit by specialising in the things they do best and then trading with others for the rest.

But the system only works if everyone plays by a common set of rules and standards. Nations won’t live happily together if they don’t. That’s what has gone wrong with globalisation. Many have just copied from the West and used cheap labour for competitive advantage. Adam Smith’s "invisible hand" cannot operate efficiently in a world of wildly different labour standards, attitudes to the rule of law and manipulated currency values. Even Smith, the father of free market thinking, recognised that markets must be policed if they are to function properly.

The Chinese are not going to get serious about intellectual property rights until they are inventing more things than they steal, nor are they going to engage in worthwhile currency reform until they have spirited every last job possible from the once vibrant West. It might be argued, as it sometimes is by Chinese officials, that they are levelling the playing field after several hundred years of relative deprivation.

That’s surely the way it is meant to work, with pursuit of self-interest working for the greatest common good. The West thought it could benefit from globalisation; it ill becomes advanced economies to complain now that they are losing from it.

All the same, the world needs urgently to embrace new forms of multi-lateralism and co-operation if it is not to slip back into an age of protectionist infighting. The free market system has become distorted to the point of virtual collapse. Unsustainable trade imbalances are the major underlying cause of today’s rolling series of debt crises in advanced economies.

In the long run, all nations must become better balanced and self-reliant. It was madness to outsource so much of what we used to do to foreign climes, just as it is unsustainable for China and other surplus nations to rely on ever-growing exports.

Where are the jobs going to come from, it is often despairingly asked, in Western economies? There’s a simple, if challenging answer: by returning to the way we were and doing more things locally. And that starts with washing our own sprouts for the Christmas dinner table.

Europe has staked its crisis credibility on Ireland. If any of EMU’s beleaguered debtor states can vindicate the EU strategy of shock therapy and wage deflation, it is surely the Celtic Tiger. "We used to be the poster child for globalisation: now we are the poster child for austerity," said David Begg, head of the Irish Confederation of Trade Unions.

More than any other EMU country on debtors’ row, Ireland has the mix of vibrant exports, a high trade gearing (over 100pc of GDP), and wage flexibility together needed to pull off an "internal devaluation", the EU’s hairshirt policy of clawing back viability once it is impossible to devalue.

A year after spiraling losses from Anglo Irish Bank pushed the Irish state over the edge and into the arms of the EU-ECB-IMF Troika, the economy has at least stabilized - unlike the downward spirals in Greece or Portugal, or aborted recoveries in Spain and Italy.

The IMF expects growth of 1pc in 2011 and 2012. Yields on 10-year bonds have been falling -- to 7.4pc in September from a crisis peak of 13.8pc - until the latest spasm of Europe’s debt crisis pushed them back up again. "We were very close to regaining market confidence, but we are just a cork bobbing along in a rough ocean," said a top treasury official.

Whether Ireland can pull off this trick for much longer as key markets in Euroland and Britain crash back into recession is the great unknown. Exports are double-edged, and the pain is about to ratchet up another notch after Dublin unveiled fresh austerity cuts of €3.8bn on Monday - more public sector attrition, less child benefit, sharply higher student fees, and a rise in VAT to 23pc.

A public debt expected to peak at 118pc of GDP in 2013 leaves no margin for bad luck, though the International Monetary Fund has trimmed the debt estimate from 125pc as bank bail-out costs of €63bn prove less catastrophic than the €80bn once feared.

Veteran finance minister Michael Noonan said Ireland had rebounded from such trauma before. "We had higher levels of debt in the 1980s (129pc) and grew our way out," he said.Wishful thinking, says Professor Philip Lane from Trinity College.

"It was catch-up growth, not plausible now". Household debt was then very low. The punt devalued. Ireland could piggy-back on the Lawson boom next door. "The politicians think we just have to cut for two or three years and then we will be through the worst, but every government for the next 20 years will have to keep cutting," he said.

Public sector pay has already been cut 14pc on average (with a pension levy), rising to 30pc for the top brass. Entry-level jobs for graduates at the big four accounting firms have dropped by a third to €21,000. Office rental costs in Dublin have halved, and home prices are down 53pc. "We have won back all the unit labour cost competitiveness against the eurozone lost since 2000. This is a massive internal devaluation," said one official.

Real GDP has contracted by 12.5pc, but that conceals a bigger slump in the day-to-day economy. Nominal gross national product (GNP) has fallen by 22pc. Unemployment is 14.3pc. Consumer demand is down a third. It is a deeper depression than the 1930s.

Yet somehow the country has held together with Nordic solidarity, bound by its tripartite "family" ethos of labour, business, and government. There has been nothing like the riots in Greece, or London for that matter. "What would we achieve by burning cars? There are dark people out there if these sorts of social forces are ever unleashed," said Mr Begg.

The country has had its electoral catharsis. Fianna Foil lost every seat in Dublin. The party of permanent rule was crushed by democratic revolution, clearing the air. Diaspora has helped do the rest as Irish youth seek work in Alberta tar sands and the iron quarries of Western Australia.

Net immigration has reached 40,000 a year. Ireland has little in common with Greece, Portugal, Italy, or even Spain (its closest twin), which coasted through the early years of EMU with half-reformed economies, losing competitiveness every year until the guillotine came down. Now they are trapped with big trade deficits.

The Irish have a current account surplus, forecast to reach 1.9pc of GDP next year by the IMF. Next exports grew 24pc from mid-2010 to mid-2011. The country can earn its way in monetary union. "Our potential growth rate is twice the eurozone average," said Danny McCoy, head of the Irish employers’ federation IBEC.

What Ireland had was a calamitous property boom. This was made worse by eurozone interest rates too low for a Tiger economy: minus 1pc in real terms for seven years on average, according to a paper by the current central bank governor Patrick Honohan. The bubble destroyed the banking system, but not the export economy built up assiduously since the early 1990s with super-low corporate taxes (now 12.5pc), a carefully-crafted industrial strategy, and a small army of science and technology graduates.

Despite the slump, Google is moving into the €100m Montevetro building on the Liffey, now HQ for its European operations. Facebook has built its regional hub in Dublin’s Docklands. Ireland’s bet on pharmaceuticals has been a life-saver. They are "recession-proof", and shipped all over the world. Half the globe’ s legally-produced Viagra comes from a Pfizer plant near Cork. Its Botox comes from Allergan’s plant in Country Mayo.

Foreign Direct Investment (FDI) has bucked the trend in Europe, rising 66pc in the first half of 2011 to $30bn. It is greater in absolute terms than all FDI into Germany and France combined over the same period (UNCTAD data).

While the EU is ordering Club Med states to undertake root-and-branch reform, Ireland is already EMU’s top state in World Bank’s global ranking for ease of doing business, placed 10th, compared to Portugal 30, Spain 44, Italy 87, and Greece 100.

Yet if Ireland is delivering on its side of the reform bargain, Europe is not -- though the penal rate on the EU’s share of the €87bn rescue has been cut by 300 basis points. There is irritation with the ECB, first for making life even harder for Europe’s broken half by tightening earlier this year, and now for refusing to act as lender of last resort as southern Europe spirals out of control.

"It is obvious that the ECB has to step up to the plate and do its job. The ECB has the capacity to get these economies moving again but it is not doing so. It is killing us all, and not only Ireland.," said one of the country’s top economists.

The anger is coloured by a dark legend - half-true - that Europe forced Ireland to take on the crushing liabilities of its bank debts to stop a chain reaction spreading to Europe. "We carried an undue burden for protecting the European banking system from contagion," said Mr Noonan, the finance minister. "Wherever there is a reckless borrower, there is also a reckless lender."

The events are murky. Dublin had no idea what it was taking on in late 2008 when it underwrote Anglo Irish, essentially a real estate speculation fund with €100bn in liabilities. "Ireland inadvertently protected Europe from another Lehman," said one official. "It was a bad idea for Ireland in retrospect, but at that moment it was systemic for the rest of Europe."

What is clear is that EU officials intervened two years later to snuff out any possibility that Dublin would walk away from senior bank debt and set a dangerous precedent. Former finance minister Brian Lenihan revealed before dying of cancer this year that he was more or less forced to go along with EU demands.

"The ECB said it would not let any bank fail if it was systemic," said David Begg from the unions. "This is their version of risk-reward capitalism: risk-free for German and British banks that lent recklessly to our ill-managed banks, while 1.8m Irish taxpayers have to pick up the tab. Well, we can’t afford to pay, it is as simple as that. The burden of debt is unsustainable," he said.

Whether he is proved right or wrong depends upon events beyond Ireland’s control. The country has shown great fortitude. It can hardly be asked to do more. The moral burden now lies with Europe’s leaders.

The most debt-burdened households in the euro zone aren't in Portugal, Ireland or Greece. Spanish households—which borrowed heavily in the boom years to build and buy houses—aren't even close to the top.

The title of most indebted goes to households in the Netherlands, and the main reason is the enormous mortgages that the Dutch—though frugal by reputation—take out.

While the Dutch government has been an enforcer of fiscal orthodoxy throughout the European debt crisis, seeking budget cuts from governments across the euro zone, household debt is a persistent worry for Dutch regulators, who see it as a major risk for the economy.

In the boom years, Dutch banks routinely wrote mortgages that exceeded 125% of the value of a home—covering closing costs, taxes, renovations and even new-car purchases on the side. Though low unemployment means most Dutch are still able to pay their mortgages, a significant drop in house prices, a rise in interest rates or an increase in unemployment would leave more people unable to pay their debts, with effects that could ripple through the financial system and the broader euro-zone economy.

"This debt makes the economy much more vulnerable to shocks in the housing market, interest rates and employment," says Gerbert Hebbink, senior economist at the Dutch National Bank. "From a financial stability perspective, we think the mortgage loan-to-value ratios are too high."

The Netherlands' large current-account surplus, at nearly 8% of GDP, and relatively low public debt, at 64% of GDP, could help absorb the shock to consumption if Dutch households face a credit squeeze. But the euro zone's tight fiscal rules and the reluctance of the European Central Bank to embark on more expansionary policy mean there won't be much stimulus from euro-zone authorities to boost demand when households start deleveraging.

In an interview in Washington on Tuesday, Dutch Prime Minister Mark Rutte dismissed worries about the Netherlands' mortgage debt. "It's not a big issue…if you look at the whole picture," he said, noting that the Dutch have saved as much in their pension funds as they have in mortgage debt—"and we have huge private savings."

The U.S. and Europe have spent much of the crisis coping with the hangover from a decadelong borrowing binge. Greece is a cautionary tale for excessive government borrowing. But the debt problems of Ireland, Spain, the U.K. and the U.S. are largely the result of popped real-estate bubbles.

Dutch households have borrowed more than their counterparts in any of these countries. In 2010, household debt in the Netherlands was more than 240% of disposable income, according to European Union statistics agency Eurostat—one of the highest levels of any advanced economy and easily the highest in the euro zone. In 1999, the figure was 140%. In the entire EU, only Danish households have more debt.

Similar factors have boosted debt levels in the Netherlands and Denmark, which isn't a member of the euro zone. In both countries, interest-only mortgages have proliferated, taking advantage of laws that allow tax deductions for interest payments. But that means less principal has been repaid. Real-estate prices in both nations have soared faster than disposable income over the past decade, and banks have been willing to lend larger and larger sums to support those prices.

The Netherlands arguably has a bigger problem. Danish law limits mortgages to 80% the value of a home, well below the typical size of a Dutch mortgage.

"This isn't public-sector debt. It's private-sector debt—but it's equally excessive," says William Xu-Doeve, a Dutch economic consultant. That wouldn't be a problem if Dutch house prices were rising. But the market has stalled since August 2008.

Hank Ydema, a 51-year-old freelance writer, and his wife bought a house in 1996 in the Amsterdam suburb of Almere, a town built on land reclaimed from the sea to make room for the region's burgeoning postwar population. They sold that house in 2003 for €190,000 (about $255,000), a 60% gain, and took out a €330,000 mortgage to buy a larger, three-bedroom house nearby. Now they are going through an amicable divorce and are trying to sell the house.

Almere's manicured suburban streets, lined with cookie-cutter houses, are dotted with for-sale signs. Although the crisis hasn't forced a lot of sales, it takes longer now to sell a house. The Ydemas' house has been for sale since June for €290,000. They have had many visitors but no buyers.

The Ydemas have paid down about a fifth of the principal on their mortgage. But interest-only mortgages are common here, so it isn't unusual for people to put their houses up for sale with principal completely unpaid. "Those families have got a real problem," Mr. Ydema said. "We can sell, and in our situation we have to sell. My wife would like to stay in the house, but with her income she can't afford it. The same for me."

Economists lay part of the blame for the Netherlands' high household debt levels on the tax deduction for mortgage interest. The policy, similar to that in the U.S., inflates real-estate values, many economists say, and encourages households to take on more debt than they can handle. It favors the rich, who are more likely to own homes and have higher tax burdens that are lightened by the deduction; and biases banks toward financing home sales and away from lending for more productive investments.

The International Monetary Fund, in its annual report on the Dutch economy released in June, recommended a phaseout of the deduction that would leave existing mortgages unaffected. But the Dutch governing coalition has pledged to leave the deduction in place.

Even without it, Dutch mortgages would be large, economists note, because housing here is expensive. The country is one of the most densely populated in the world. Open space is seen as a precious commodity, and the government closely controls all construction to prevent sprawl. That means housing supply isn't very responsive to house prices. Municipal authorities, not market forces, control how, when and where housing is built.

Government planning is evident here in Almere, one of the few places in the Netherlands where lots of new housing has been built in recent decades. The city is divided into tidy wijks, or districts, whose street names share whimsical, easy-to-remember themes. There is "Danswijk," with streets named after the tango and the salsa. Mr. Ydema lives in Filmwijk.

Almere has been a magnet for first-time buyers. But banks, under pressure from authorities, have tightened lending standards, and sellers don't want to lower prices further. That has left many younger buyers locked out of the market. "The current level of house prices is on the edge of what is affordable, considering that there is a generational effect in the housing market," said Mr. Xu-Doeve, the economic consultant.

A key question now is what will happen to the housing market. Housing prices were down nearly 9% nationwide in August from August 2008, according to the Dutch statistics agency. That is significant but still far less than the double-digit declines over the same period in the U.S., Spain, Ireland and the U.K.

Dutch unemployment—at 4.3%, the euro zone's lowest—has a lot to do with this, experts say. Job losses haven't turned homeowners into forced sellers. "That situation seems far away at the moment," said Jan Rouwendal, an economist at the Free University Amsterdam, "although we know things can change rapidly."

With the United Kingdom opposed to Chancellor Merkel's plan for amending EU treaties to increase fiscal integration, Germany and France are seeking a separate agreement among the 17 euro-zone members. That, though, may be illegal say many.

It was just a few hours before the beginning of the European Union summit in Brussels when German Chancellor Angela Merkel and French President Nicolas Sarkozy finally got the support they needed. If necessary, said Jean-Claude Juncker, head of the Euro Group and prime minister of Luxembourg, the 17 euro-zone countries could agree to changes to EU treaties on their own, without the participation of the other 10 EU members.

Early Friday morning, the significance of Juncker's move quickly became apparent. British Prime Minister David Cameron indicated that he wasn't prepared to join EU efforts to significantly alter the Lisbon Treaty in order to increase fiscal unity and strengthen debt and deficit rules by making penalties automatic.

"What was on offer is not in Britain's interest so I didn't agree to it," Cameron said. "We're never going to join the euro and we're never going to give up this kind of sovereignty that these countries are having to give up.

The euro-zone 17 in combination with six other countries quickly began moving forward on their own. But is such a move legal? European Union lawyers have their doubts that the kind of euro-zone fiscal union within the EU would be allowed.

Changes to the EU treaty, after all, must be unanimous. Furthermore, EU officials in Brussels say, because monetary union is regulated extensively in the Lisbon Treaty, reform can only be implemented within the existing legal framework. The legal services experts of the European Commission, the European Central Bank and the European Council, which represents the member states in Brussels, are all in agreement. A treaty concluded only by the 17 euro-zone governments would be illegal, they say.

Trying to digest events, in particular the actions of my Dear Leader, “Dave”Cameron, and his Tory Party. They justify their actions as defending Britain’s interests, but when pressed on those interests it is clear that the independence of the City of London, or in other words “our” banksters, is the pre-eminent “interest”.

The article from Zerohedge in Ilargi’s post is most illuminating on the subject of this “independence”. To summarise, it is this “independence” under the last Labour govt that led to the collapse of AIG through effectively unlimited expansion of the shadow banking system thanks to a loophole in UK law that was fully exploited by AIG’s London office . The opposition Tories excoriated Labour at the time for their regulatory failure but after 18 months in office the Tories have done nothing to address this, and now the vanishing of the assets of MF Global’s customers has occurred through MF Global’s office in …… London, U.K. – thanks to precisely the same loophole.

So, this is the “freedom” that Cameron is prepared to defend even if it means losing our place in the Single European Market, even if it means the opprobrium of the rest of Europe, who will be even more convinced now that we are a bunch of arrogant pr**cks, and the sooner we absent ourselves from the European project the better.

As for our getting into bed with our "natural ally", the US, after the AIG and MF Global debacles we can't assume a warm welcome there.

While I completely agree with you about Cameron and the UK in general, I think the broader story here re: Cameron's veto is still how "democratic", and specifically parliamentary, systems continue acting as a force against coerced fiscal integration of Europe, however slight that force may be. As we all know, even the slightest force in this environment can lead to out-sized effects, like the butterfly flapping its wings.

A few months ago, those butterflies were G-Pap and Berlusconi, even though their motives were clearly anything but genuinely in the best interests of their people. Now, it's Cameron. Each time this happens, a lot of confidence is lost in the European integration dream, and more countries start to really reflect on the price they must pay. Specifically in terms of the treaty changes proposed in this Summit, it seems that it is only UK forcefully resisting right now, but I suspect that could change on the drop of a dime as markets and sociopolitical mood deteriorates much faster than any political process to change treaties can progress.

Then... we have all the other factors weighing heavily against further integration, which includes hesitation by several other countries, the lack of time and, let's not forget, the simply unworkable math of the underlying situation. So while the UK is just as despicable as the US in the broader scheme of things, it has done wise to remain apart from the monetary union and to continue resisting efforts to override its "sovereignty" in the matter.

Sounds like a rock/hard place problem. I completely agree with your thesis that Cameron's prime purpose is to protect the banksters in the City, and that if you leave the EU, they will have even more influence in the government.

However, what appears to be 'on offer' from Merkozy is that the UK help bail out the EZ's banksters, while getting no help with your own. If I am correct, Cameron is also correct that this deal is not advantageous to the UK.

Someone over on ZH claimed that the UK's net contributions to the EU are 65 billion pounds, twice your defense budget, and second only to Germany's. If correct, this is serious leverage. Sarkozy doesn't want his farmers to lose their subsidies.

"Merkel also ran through the main agreements on Europe’s rescue funds, restating the main summit conclusions that the European Central Bank will advise the European Financial Stability Fund (this is supposed to allow the EFSF to get up and running quickly, without having to shop around for the kind of market expertise at ECB HQ in Frankfurt). The combined resources of the EFSF and the European Stability Mechanism (planned as the permanent successor to the EFSF) will be capped at €500bn. The ESM will swing into action in the middle of next year, earlier than planned."

"The Dutch conservative government gets its majority parliament from the zealously anti-Europe Party for Freedom of Geert Wilders, which votes against anything beginning with the letters “euro”. In order to get anything done on the euro crisis, PM Mark Rutte needs the support of the left-wing pro-European opposition.

Today, that problem just got worse. The entire Dutch left-wing opposition hates yesterday’s deal. The idea of implementing European fiscal integration via a smaller group of member states, not including the UK, was denounced as a half-measure that will only complicate the crisis."

"Despite comments from European Council president Herman Van Rompuy that 26 leaders are in favour of joining the new treaty, there is still the prospect of referenda among the 9 non-eurozone members. Sweden perhaps, whose finance minister said earlier they have an open mind on signing up to the treaty changes.

And Ireland's Europe minister admitted today there is a now a 50-50 chance that the Republic may have to hold a referendum on any EU treaty emerging from the European summit."

I see markets giddily moving higher on both sides of the pond, and then I read that 17, 23 or 26 EU nations (pick your fave number) will have to change their constitutions to incorporate "debt brakes".

And I wonder how many of those nations will even still have the same government by the time that's done, if ever.

But even that may all be moot. Germany and France pushed for a change in decision making from a required unanimity to a majority, and they didn't get it.

So it would seem to can't change any treaty unless Britain signs up too. What are they going to do? Throw Britain out? Here's thinking that also would require a unanimous decision, so Britain would have to agree to be thrown out.

"The leaders of France and Germany have more or less bulldozed Britain out of the European Union for the sake of a treaty that offers absolutely no solution to the crisis at hand, or indeed any future crisis. It is EU institutional chair shuffling at its worst, with venom for good measure.

It is risky to reach instant conclusions on a fast-moving story but it looks as if the EU may soon be reduced to a shell, with a new union forming among the core.

Much has been said about whether David Cameron handled this well or badly. I leave that debate to my colleagues. What strikes me as a former EU correspondent is how threatening this is to the EU Project itself..."

Mr. AEP calls them "blithering idiots" and perhaps others agree, but it appears to me those folks are faced with an evolved, insurmountable, and unsolvable predicament.The world may well be heading for a train wreck but I would think we should spend less time throwing stones and more time offering suggestions and salvaging resources.What does Mr. Evans-Pritchard suggest?

Here is a comment I posted on The Archdruid Report that I thought would be of interest here. Has anybody seen such a thing?

As I was reading I thought "This is What Peak Oil Looks Like" really needs an infographic--a chart that could graph peak oil along with other data sets:-wage in real dollars, -miles of paved road, -miles of gravel road (many cities are converting back to gravel), -miles of transit system, -number of potholes-number of operating canal locks-number of firefighters-incidence of basic diseases

The problem is that banks have lent money and lost their investments. They have lost their cash flow from those investments.

The banks do not have any income stream to continue their operations..The banks will not lend, (Print money), to each other by taking bad collateral in exchange.

So the banks went to the governments to lend them money, (print money). That new printed money is being used to replace their bad investments and to give them a cash flow.

This free cash flow money is being used to make the stock market look good. It is preventing the stock market from going down because if it did then we would all see the bad investments of the banks.

The banks are "recapitalized" by the governments.

Since the banks are not telling all the truth and only the truth, all at once, we keep seeing that the governments are now stuck in a position of giving more good money after bad money.

Since all those in the financial system are finding new and creative ways to get an advantage over their competitors, think MF Global, the governments will eventually find out that they are being used and that they will have to let one of the players go bankrupt.

If the players make a mistake in letting wrong one of their own take the fall, then it could bring down "the fire walls" and spread.

The players have got their fortunes and future in this high stake poker game. Somebody will lose their fortune. As can be seen, the London bankers want to make sure that they won't be the ones losing.jal

""The ECB said it would not let any bank fail if it was systemic," said David Begg from the unions. "This is their version of risk-reward capitalism: risk-free for German and British banks that lent recklessly to our ill-managed banks, while 1.8m Irish taxpayers have to pick up the tab. Well, we can’t afford to pay, it is as simple as that. The burden of debt is unsustainable," he said."

To our fellow citizens of the world in Ireland: Remember Iceland. Seize the bankers- and their assets, now. Then seize their lawyers; and their assets. Those are the genuine criminals- treat them that way. The sooner the better. Iceland Lives!

VK is alive and well. I think he is now more involved with the twitter or FaceBook side of TAE. I don't do social media so I am not sure. Actually, VK told me how to quit FaceBook. They don't make it easy. Good thing too as I was about to convert the remnants of my savings into Zynga dollars. Was picking a lot virtual cotton down on the virtual plantation. Now I shoot off a lot of virtual Glock .40's.

Hombre

AEP is in favor of saving the corrupt global banking system, and in particular, the City of London, which is the most corrupt of the corrupt. When Wall Street needs a little extra corruption octane booster in their tank, they go to the City, as in Lehman, AIG, and MFG. He is, I believe, in favor of the ECB printing like hell crusade as long as the UK stays with the pound. On a gut level, AEP cannot imagine a world worth living in without the corrupt privilege of the O.O1%. The truth is that I do not pay much attention to what AEP is in favor of, but I know that it is inimical to my interests.

Greenpa

Ireland just bailed out their banks firstest with the mostest. German debt slaves will have their turn, just have to wait a bit. CommerzBank could blow up any hour. I wonder if the ECB really sent Ackermann that bomb?

Iceland is heretical in that it refused to recognize the gambling losses of its ubercriminal private bankers (now safely ensconced in London despite a theoretical pan European warrant for their arrest) as national, sovereign debt. ¡¡The Horror!!

"Markets reacted positively to the summit conclusion today, but it wasn't always clear why. Neal West of Barclays Capital, said:

'For large parts of today I had genuinely no idea what was going on. I had a lot of emails and reports giving ‘chapter and verse’ about the summit and how ‘Dave’ had said “non” to a full treaty (apologies, that appears to be the bankers' fault, again).

But as Sir Humphrey would say, all we knew was there is something we don't know and we want to know but we don't know what because we don't know! Hence I really struggled to have a clue why markets were reacting the way they were.'"

The writing is Farsi - most of the letters are the same as Arabic, just a different font and pronounciation. The voice-over is repeating that this is a spy plane from the USA that entered from the East (i.e. Afghanistan/Pakistan). He mentions the external dimensions of the gadget in metres. Nothing that cannot be found in greater detail on the Wikipedia. It does not look damaged to me. I guess the Americans may have landed it and hoped to rescue it somehow but that the Iranians got there first. I am surprised the American didn't try to destroy it somehow. Maybe they didn't want to escalate matters. The whole thing does not make much sense as we are not being told the real story by either side.

JMG's latest generally outlines the capitalist industrial system as one involving two very inter-related factors - 1) wealth concentration and 2) energy arbitrage. Both, of course, have rapidly reached their limits.

"In The Power of the Machine, Alf Hornborg has pointed out trenchantly that the industrial economy is at least as much a means of wealth concentration as it is one of wealth production. In the early days of the Industrial Revolution, when the hundreds of thousands of independent spinners and weavers who had been the backbone of Britain’s textile industry were driven out of business by the mills of the English Midlands, the income that used to be spread among the latter went to a few mill owners and investors instead, with a tiny fraction reserved for the mill workers who tended the new machines at starvation wages. That same pattern expanded past a continental scale as spinners and weavers across much of the world were forced out of work by Britain’s immense cloth export industry, and money that might have stayed in circulation in countries around the globe went instead into the pockets of English magnates.

Throughout the history of the industrial age, that was the pattern that drove industrialism: from 18th century Britain to post-World War II Japan, a body of wealthy men in a country with a technological edge and ample supplies of cheap labor could build factories, export products, tilt the world’s economy in their favor, and make immense profits. In the language of Daly’s essay, industrial development in such a context was a bankable project, capable of producing much more than ten per cent returns. What has tended to be misplaced in current thinking about industrial development, though, is that at least two conditions had to be met for that to happen. The first of them, as already mentioned, is exactly the sort of protective trade policies that the World Bank and the current economic consensus generally are unwilling to contemplate, or even to mention.

The second, however, cuts far closer to the heart of our current predicament. The industrial economy as it evolved from the 18th century onward depended utterly on the ability to replace relatively expensive human labor with cheap fossil fuel energy. The mills of the English Midlands mentioned above were able to destroy the livelihoods of hundreds of thousands of independent spinners and weavers because, all things considered, it was far cheaper to build a spinning jenny or a power loom and fuel it with coal than it was to pay for the skilled craftsmen and craftswomen who did the same work in an earlier day. In economic terms, in other words, industrialism is a system of arbitrage."

Frankly, I think anyone in favor of maintaining a global, industrialized capitalist system is inimical to the broader interests of humanity. Though, it usually doesn't win us any brownie points to take such a hard-line stance with others or with ourselves, even in these desperately trying times. So while I'm more eager to read AEP's analysis than listen to - let's throw a random name out there - Barnhardt's analysis cum racist rants, I feel that both of them are within a stone's throw of each other in terms of completely misguided perspectives on what's laying at the foundation of our predicaments, and therefore what the best paths forward are or should be. By that same token, I can't afford to ignore their views or the views of someone much more respectable like... Tyler Durden, because if I did, well, I'd probably just go stir crazy with my own "perverse" thoughts.

"Senior analysts and traders warned of impending bank failures as a summit intended to solve the European crisis failed to deliver a solution that eased concerns over bank funding.

The European Central Bank admitted it had held meetings about providing emergency funding to the region's struggling banks, however City figures said a "collateral crunch" was looming.

"If anyone thinks things are getting better then they simply don't understand how severe the problems are. I think a major bank could fail within weeks," said one London-based executive at a major global bank.

Many banks, including some French, Italian and Spanish lenders, have already run out of many of the acceptable forms of collateral such as US Treasuries and other liquid securities used to finance short-term loans and have been forced to resort to lending out their gold reserves to maintain access to dollar funding."

I know its not going to be a very popular opinion but the people are very much complicit in this unfolding crisis. Very easy to blame the bankers and politicians.

But who gave them the power and social standing?

We don't even think twice about using our finite fossil fuel reserves and we don't really give a damn about climate change.

At its heart the global financial crisis is a cultural crisis. The easy way out is preferred, difficulty and sacrifice is despised, entitlement all round - rights without obligation and image over substance.

The only way to 'save' ourselves is if we wake up in a different plane of consciousness. One with responsibilities, sacrifices, obligations and substance. These are all traits of community. Communities which have now entirely been broken in most Western societies and increasingly elsewhere.

What's sexier than liberated, promiscuous money that allows us much pleasure and the pain is delayed till the next generation. Well, nothing! As money has now trumped everything. It is the means and the ends and everything is subservient to money.

"But why would BSC be so willing to sell protection? Well, the markets were very wide because of the fear that they would default. You sell as much protection as possible. If you default what do you possibly care? Your stock is wiped out, your job is gone, and your strategy is totallly explainable to future employees. If you don't default all this massive amounts of protection screams tighter and you have your best year ever. No brainer for the firm, an issue for the market.

So, why are French banks selling protection on France like it is going out of style? Why are Italian banks doubling down on Italy? Because if the bailouts work, it is free money. Huge tightening on top of the spread income until the bailout finally wins. If the sovereign defaults, is the bank really going to be around anyways?

It is the ultimate trade.

If you make money, you get paid. If you lose money you were screwed anyways."

VK: "I know its not going to be a very popular opinion but the people are very much complicit in this unfolding crisis. Very easy to blame the bankers and politicians. "

Well. Yes. But. We humans tend to believe that we are fully in charge of our own decisions. We have some religions that really try to pound that into us, also; "mea culpa", etc.

There is, however, a large body of evidence which suggests otherwise; that all of us, sheeple, bankers, and intellectuals (in the original sense), are actually far more "herd animals"; and our decisions tend to follow our own herd's proclivities far more than be the result of a calm rational consideration of facts.

VK"The only way to 'save' ourselves is if we wake up in a different plane of consciousness. One with responsibilities, sacrifices, obligations and substance. These are all traits of community. Communities which have now entirely been broken in most Western societies and increasingly elsewhere."

Although I think it's a bit harsh to blame the people for what's been done to them and in their name, I do agree with the above. In that respect I have "found" my community: it is the Occupy Movement, specifically Occupy Vancouver. I don't expect them to save me materially but they've already saved much of my sanity and my atheistic spirituality.

So by your analysis, Stoneleigh, by taking a plane to Europe and back to give lectures on preparation, and thus participating in resource depletion and global climate change, is **equally** culpable as Lord Blankfein and Jaime Dimon.

Greenpa

A recent article in Science proves that rats are far more empathetic and helpful to their fellows rats than Banksters to their fellow rats. No shit! Just published in Science and ironically the research came out of that bastion of neocon sewerage, the U. of Chicago. Maybe Blankfein and Dimon are not making enough snout to snout contact.

http://www.cbc.ca/quirks/media/2011-2012/qq-2011-12-10_01.mp3

Also, the brilliant and beautiful Janet Tavakoli deflates some myths that Corzine found loopholes to insulate himself from felony fraud. He is guilty as shit by the letter of the law if Eric PlaceHolder didn't have his butt superglued to his chair.

His decision to 'go-it-alone' from the Euro crowd had nothing, absolutely nothing, to do with the best interests of England, much less the people of England, and less than nothing to do with any conceivable 'principled' stance against 'giving up sovereignty' to the Euro Puta, just a different crime syndicate who'd like nothing better than to get a piece of the City's 'action'.

The City of London has nothing to do with England, it is a criminal enterprise with allegiance to nothing but itself. You could saw the City off the mainland of England, float it down the Thames and anchor it in international waters and it would not miss a single criminal heart beat, not one.

It is safe haven to every financial gangster and terrorist from every country on the face of the earth. It is the Capital of Financial Fraud for the World, far more than the syphilitic alleyways of Wall St. All you have to do is pay the bribe of depositing your stolen loot in City bankster accounts and you get a out-of-jail-free card, good in every jurisdiction on Earth.

All major financial blowups to date originate there because there are no regulations at all, and everyone in business and politics knows this.

The only extradition warrant they back is against Julian Assange, not the psychopathic financial criminal class destroying the global economic system.

And Ambrose Evans-Pritchard by the by is Cameron's toy buttboy, cheerleading with his high kick step and shaking his pom-pom-ed booty from the sidelines, in case you need a peek at the organizational chart of a criminal syndicate.

I read all view points and glean what ever I can, even AEP's. In his case however, always with a grain of salt and in the context of listening to a City Dweller.~

Could you give some of your recommended reading on herding behaviour (though I think it may be to our advantage to call it flocking)?

I have read the book Herd, which a marketing book, but then got sidetracked down the path of how little consciousness affects behaviour, courtesy of Sandy Pentland and Robert Provine.

Before I became my girlfriend's live-in gardener I was a bureaucrat studying how to foster pro-environmental behaviour, like recycling and water conservation etc. I think the flocking angle is huge, but could use some more good research on it.

I will watch the comments, but you could also email at my disposable address porkpie(symbol)mailinator(symbol)com

I maybe American but I am not an idiot. These treatises are so complex and so hair brained. They remind me of the ones that existed to stop Europe from going into war back around early 1900s. While they did wonders for preventing small scale war between single nations it did a fantastic job at promoting large scale war between many nations.

Seven billion of us are struggling through the most sever ecological, financial, political and spiritual crisis. This time the catastrophe we face doesn't affect a single nation or region or continent...it is all more terrifying because it is global and simultaneous. Odds are that if we can't pull out of this decline then we just might descend into a horrifying thousand year long dark age...an age of scorched earth authoritarian capitalism, brutalism and mayhem which will make all the genocides and holocausts of the previous century feel like foreplay. We're not only running out of ideas; we're running out of time.

Now more than ever we need to create breakthroughs and outlier brainstorms than can shift the terrain of thought, revealing exits, opening possibilities, potentially, saving us all. We need mavericks of indie media who can kill the commercial virus that infects our information flows. We need brilliant new crop of economists who can stand up to their professors, topple the neoclassical paradigm and replace with a true cost model. We need potent mew ways of dismantling corporate rule and corporate personhood. And then there is the biggest challenge of them all: How to spark and social revolution, an insurrection of everyday life that sweeps across the globe just in time to avert the final catastrophe.

We may be in the midst of an irreversible mental breakdown of the human race that parallels the irreversible collapse of our planet's ecosystems. This eco-psycho spiral may do us in. Maybe it is already to late?

But this issue is not about despair, it is about hope and revolution and living without dead time...it's about testing the waters and discerning whether we can muster the psychic energy for an almighty turnaround.

for the wild,

Kalle Lasn and Micah White

Why is it easier to imagine the end of the world than the end of capitalism?

A little off topic, but it is the weekend. This two minute video was posted on the Max Keiser site today. I think there is a metaphor to the global banking cartel, but I can't quite make it out. Any ideas?

They are not mutually exclusive, but they are not mutually inclusive, either. Meaning, it is possible to end capitalism without "ending the world". The import of that question, though, is revealing the mainstream psychology that permeates the developed world. One in which people cannot imagine a world without a capitalist market system, because they are so attached to it and so used to operating within it. It is not really possible to do anything until that psychology changes, which I believe it currently is in some meaningful ways. Whether that change will be large and rapid enough to significantly mitigate the "end of the world" scenario remains to be seen.

My brief question was not meant to imply that capitalism is in any way conducive to the continuation of the world. And yes I could personally imagine a much happier and healthier world without it. Nor do I believe that capitalism is intrinsic to human nature. What my comment was meant to imply was that I see a substantial possibility that capitalism, like Samson, will pull the world down with it in its death throes.

For example: I am not a big fan in many respects of Jack Kennedy, but I believe that if any other president the USA has had since FDR were president during the Cuban Missile Crisis, the world would not be here today. Kennedy was pro life in the sense that he had two young kids who he wanted to see grow to maturity. We missed the end of the world by an unlikely and improbable razor edged stroke of good luck, but like flipping a quarter heads 10 times in a row, we cannot expect it to be repeated indefinitely. The events leading to WW I are ample evidence of what idiots the world "leaders" are.

As an elaboration on the parable of the blind men and the elephant, in order to understand the big picture I go to a number of trusted "blind" observers who are pretty good at understanding and explaining their take on the part of larger picture that they know the most about.

I must admit that TAE and the commentariat is my most favored and trusted source for the information with which I construct my own big picture of the elephant.

Richard Wolff is one of these, and though he has his limits, his economic update on WBAI today was great- particularly his interview with Victor Wallis. Even if you are already pretty familiar with Wolff's schtick, I think you may be pleasantly surprised by this one.

http://www.rdwolff.com/content/economic-update-wbai-dec-10

And thanks Ilargi, as soon you reminded me about those icons, I remembered having seen them. Funny how we can grow so accustomed to something we have seen so many times, we cease to see it at all.

Interesting thoughts on Kennedy - last night I brought up the Cuban Missile Crisis in conversation with my spouse and I made a good argument that Kennedy's decisions at that time were possibly more important to the future of the US than any real decision that a president has actually dealt with since.

I may have been a little motivated to steer the conversation because I wanted to watch a movie I recorded - The Adjustment Bureau. It was a pretty entertaining movie.

The UK gets pistol whipped with a special nod to their 1000% debt to GDP and a private banking debt four time GDP, higher total debt than Japan which is OMG nose bleed stratospheric.

At one point Max and Das get on the topic of whether the political class understands that they are on a runaway train of deflating options and that their complete disconnect from 'the little people', which is a perfect segue for "You're either at the table or you're on the menu", puts them in the center of the big fat lethal Bull's Eye.

It starts about 20:00 into the interview that Das reiterates a point I&S have repeatedly made that on the way up in the ponzi complexity expansion, leaders look all powerful. In a deflating decomplexifying contraction, 'the leaders' look like Eunuchs at an orgy.

Das has a little quip about 'the powers that be', "I think they're running out of runway."~

Now that's interesting you recorded The Adjustment Bureau, because I just finished watching it too. It is a good movie, especially as a metaphor for how increasing centralization, complexity and order comes at the cost of suppressing "free will". One of the guys makes a reference to the "Dark Ages" as a time when they let free will reign, and, contrary to modern mainstream belief, they weren't so "dark" at all.

It's harder to make the case for WWI, WWII (the Holocaust) and the Cuban Missile Crisis, and in reality those were more the consequence of systemic institutional pressures than free will. If the Bureau were to be analogized to society's sociopathic elites, then the ending was a major cop out! (not going to say what it was, but I'm sure you know what I mean). If the Bureau is analogized to the system of human civilization itself, OTOH, then I guess it's more acceptable.